The US Securities and Exchange Commission has approved New York Stock Exchange rule changes that will grant the exchange discretion to allow companies to raise money by selling common shares in registered direct offerings, increasing the number of alternatives to traditional initial public offerings.
The US Securities and Exchange Commission (SEC) on December 22, 2020, released an order approving changes to the rules set forth in the Listed Company Manual of the New York Stock Exchange (NYSE). The revised rules will allow companies to raise money in a primary direct listing on the NYSE, referred to as a “Primary Direct Floor Listing,” on a case-by-case basis. In these types of listings, a company sells shares of its common stock to the general public in an auction on the first day of trading, instead of to a subset of investors through an underwriter.
Previously, only secondary direct listings, now referred to as “Selling Shareholder Direct Floor Listings,” were allowed, so only the existing stockholders of a company, but not the company itself, could sell common shares in the initial auction of the company’s shares to the public.
Nasdaq has also submitted an application to change its rules to allow primary direct listings. As a result, there is now another viable alternative to the traditional, underwriter-intermediated initial public offering (IPO) that may become a popular route to public company status for issuers and an exit for investors in private companies.
In a traditional direct listing (i.e., a Selling Shareholder Direct Floor Listing), a private company files a registration statement on Form S-1 with the SEC to register the resale by its stockholders of securities that the company has sold in private, unregistered offerings. The company also applies for the listing of its securities on an exchange. Once the Form S-1 is declared effective by the SEC and the exchange certifies the listing of the securities, the selling stockholders sell their shares to the public, while the company takes on the reporting and other obligations of a public company.
While financial advisors are involved, there are no underwriters involved in setting the price to the public for the securities, so the price for the securities is initially set during the opening auction on the first day of trading. Additionally, without underwriters, there are no contractual lockups, allowing insiders and existing stockholders to trade in the securities immediately, rather than having to wait for a lockup period to end.
A company going public through this type of transaction is still required to meet the minimum listing requirements for the exchange, which in the case of a Selling Shareholder Direct Floor Listing on the NYSE include a minimum value for publicly held shares of the company (defined as all shares other than those held by directors, officers, and their immediate family members or by holders of 10% or more of the company’s equity) set at (1) if there has been recent, sustained trading over a several-month period in a trading system for unregistered securities operated by a national securities exchange or a registered broker dealer, $100 million, based on the lower of (i) an independent third-party valuation or (ii) the most recent trading price for the security, or (2) if there has not been such recent trading, $250 million, based on an independent third-party valuation.
A Primary Direct Floor Listing is the same as a Selling Shareholder Direct Floor Listing, except that the issuer sells shares of its common stock directly into the market—a capital-raising transaction. This may occur alongside a selling stockholder resale component, as in a Selling Shareholder Direct Floor Listing, or an issuer may use the Primary Direct Floor Listing solely to raise funds. In either case, the offering structure will be described in the Form S-1 filed to register the offering, and the Form S-1 will include a price range for the shares offered by the issuer, similar to a traditional IPO.
In the case of a Primary Direct Floor Listing, the minimum listing requirements include either (1) selling shares worth at least $100 million during the direct listing, or (2) if the registrant will be selling shares worth less than $100 million, the aggregate value of the shares sold and the shares that are publicly held after the offering, collectively exceeding $250 million. The market value will be calculated using the lowest price in the price range in the issuer’s Form S-1.
For either a Primary Direct Floor Listing or a Selling Shareholder Direct Floor Listing, the issuer will need to meet all of the NYSE’s other listing requirements (e.g., certain qualitative listing standards as well as corporate governance requirements) in addition to the market value requirements outlined above.
To sell shares offered by an issuer, rather than selling shareholders, in a Primary Direct Floor Listing, the NYSE has introduced a new order type: the Issuer Direct Offering Order (IDO Order). This is a limit order (meaning that the stock can only be sold at the limit price or above) that cannot be canceled or modified once entered, and is traded only in the context of the listing auction for a Primary Direct Floor Offering. Only one IDO Order may be entered for an amount of shares equal to that being offered by the issuer, and the limit price must be equal to the lowest price in the price range in the issuer’s Form S-1. The IDO Order must be executed in full during the listing auction.
The IDO Order is carried out by a designated market maker (DMM) who has been selected by the NYSE as the primary market maker in the securities being offered, is responsible for maintaining quotes and effectuating transactions, and determines the auction price. A DMM cannot conduct the listing auction for a Primary Direct Floor Listing if the auction price would be outside the range of prices in the issuer’s Form S-1, or if the DMM is unable to sell all of the offered securities.
A Primary Direct Floor Listing may be carried out with much less cost and restrictions on the issuer than a traditional, firm underwritten IPO—there are no underwriting fees and no lockup periods preventing insiders and existing stockholders from selling their holdings. However, since underwriters will not be purchasing the offered securities directly from the issuer, there is a chance that a Primary Direct Floor Listing may be canceled due to a lack of interest in the issuer’s shares, either at the auction price or in the full amount of shares offered.
This risk may be ameliorated through the use of seasoned financial advisors who can accurately gauge interest prior to the filing of the Form S-1 with the size and price range for the offering. Of course, the financial advisors assisting the issuer and the DMM must continue to comply with the federal securities laws, including Regulation M and other antimanipulation requirements. The financial advisors may also be deemed statutory underwriters, and thus exposed to the relevant liability provisions of the Securities Act of 1933, as amended.
Due to the need to meet the NYSE’s other initial listing requirements as well as the market value requirements discussed above, Primary Direct Floor Listings will not be available to all potential issuers. For example, a very closely held private company may be unable to pursue a Primary Direct Floor Listing without further sales of equity by the issuer or existing shareholders to reach the 400 round lot stockholders or 1.1 million publicly held shares outstanding requirements.
Nasdaq’s proposed primary direct listing would allow for listings where the combined value of publicly held shares and the amount offered in the primary direct listing would be at least $100 million (or, for companies with stockholders’ equity below $110 million, in excess of $110 million). The market value would be calculated using the bottom end of the price range in the issuer’s Form S-1, reduced by a further 20%.
As with the NYSE, an issuer would be required to meet all other listing requirements at the time of listing.
With the approval of the NYSE’s proposal to allow Primary Direct Floor Listings, another alternative to a traditional IPO has emerged—one that may offer a path to liquidity for insiders and public company status with much less cost than an IPO, albeit with a bit more risk.
With Nasdaq expected to follow suit, the availability of this sort of initial offering will likely soon become broader. For companies able to meet the other listing standards of the NYSE or Nasdaq, these could provide attractive (and attractively priced) alternatives to working with an underwriting syndicate.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
David C. Schwartz
David A. Sirignano