Amidst the clamorous and wide-ranging debate over poison pills, few commentators have addressed whether these corporate defenses are consistent with NYSE’s and NASDAQ’s well-known prohibitions against large issuances absent shareholder approval (the “20 Percent Rule”). While poison pills are often assumed to qualify under the 20 Percent Rule’s public offering exception, current NASDAQ interpretative guidance regarding this exception casts doubt on that assumption. Thus, the triggering of a poison pill places a listed company at risk of noncompliance with the 20 Percent Rule and possible delisting. Because the U.S. Court of Appeals for the Second Circuit has recognized that a corporation’s listing is a valuable asset, the loss of which can create irreparable harm, the triggering of a poison pill could give rise to some severe legal side effects.
The 20 Percent Rule Explained
Nasdaq Rule 5635 (the “NASDAQ 20 Percent Rule”) “sets forth the circumstances under which shareholder approval is required prior to an issuance of securities in connection with . . . transactions other than public offerings.” Specifically, “[s]hareholder approval is required prior to a 20% Issuance at a price that is less than the Minimum Price.” Minimum Price is defined as the lower of the pre-transaction closing price and the average closing price for the five days preceding the transaction. Moreover, a 20 percent Issuance is defined as a “transaction, other than a public offering as defined in IM-5635-3, involving the sale, issuance or potential issuance by the Company of common stock (or securities convertible into or exercisable for common stock), which . . . equals 20% or more of the common stock . . . outstanding before the issuance.” Thus, the definition of a public offering operates as an exception to the NASDAQ 20 Percent Rule.
Similar to the NASDAQ 20 Percent Rule, NYSE Rule 312.03(c) (the “NYSE 20 Percent Rule”) requires shareholder approval “prior to the issuance of common stock, or of securities convertible into or exercisable for common stock, in any transaction” where the “number of shares of common stock to be issued is, or will be upon issuance, equal to or in excess of 20 percent of the number of shares of common stock outstanding before the issuance.” Like the corresponding NASDAQ 20 Percent Rule, there are exceptions for “public offering[s] for cash” and “bona fide private financing[s].”
In addition to listing five factors for determining whether a transaction is a public offering, NASDAQ has offered interpretive guidance addressing the applicability of the public offering exception to rights offerings. In Staff Interpretation Letter 2012-5 (the “Interpretation Letter”), NASDAQ opined that a rights offering was a public offering (and thus exempt from its 20 Percent Rule) “because the rights [were to] be distributed generally to all shareholders of the [issuer] pro ratably and all shareholders [were] entitled to participate on the same terms.” The Interpretation Letter further explained that the presence of a backstop agreement, which could have allowed one shareholder to accumulate much of the offering, did not alter the analysis because “purchases by the backstop provider [were to] be made on the same terms available to all the [issuer’s] shareholders and made only after those shareholders decline[d] to participate.”
Applying the 20 Percent Rule to Poison Pills
While the modern poison pill has only been triggered once, the NASDAQ 20 Percent Rule covers “potential issuance[s]” and both the NASDAQ and NYSE rules cover “securities convertible into or exercisable for common stock.” This language appears to cover rights offered to shareholders as part of a poison pill because the triggering of the pill involves the issuance of more than 20 percent of outstanding stock. In fact, NASDAQ guidance regarding notifications of the Listing of Additional Shares (LAS) effectively concedes this point. Nasdaq Rule 5250(e)(2)(D) (the “NASDAQ LAS Rule”) requires that a listed company provide NASDAQ 15-days’ notice prior to “issuing any common stock, or any security convertible into common stock in a transaction that may result in the potential issuance of common stock (or securities convertible into common stock) greater than 10% of . . . the total shares outstanding.” Furthermore, NASDAQ has publicly stated that “[a]n LAS Notification must be filed 15 calendar days prior to distributing rights or adopting a poison pill, if the exercise of the rights or triggering of the poison pill may result in the issuance of common stock greater than 10% of . . . the total shares outstanding.” Thus, NASDAQ, in considering a poison pill to be a “potential issuance” under the NASDAQ LAS Rule, compels a similar result when considering if a poison pill is a “potential issuance” under the NASDAQ 20 Percent Rule.
Moreover, the public offering exception, particularly under the NASDAQ 20 Percent Rule, appears unavailable based upon the Interpretation Letter. The Interpretation Letter suggests that if “all shareholders” are not “entitled to participate on the same terms,” the public offering exception is not available. A typical poison pill, where rights to acquire discount shares are distributed to all shareholders except the hostile shareholder, presents unequal terms to hostile shareholders.
The Consequences of Risking Delisting
While the 2008 triggering of Selectica’s poison pill did not result in the permanent delisting of Selectica’s shares, exchanges have launched inquiries into listed companies that issue shares in violation of shareholder approval rules. For example, NYSE contacted Lions Gate Entertainment in 2010 to inquire whether their placing a substantial block of stock in the hands of a friendly investor in an effort to fend off a hostile bidder violated NYSE shareholder approval rules. While NASDAQ did not object to the triggering of Selectica’s poison pill in 2008, one instance of non-enforcement provides little comfort in light of NASDAQ’s current interpretation of the public offering exception.
Moreover, the Second Circuit has recognized that actions that risk delisting can pose irreparable harm to a listed company. In Norlin, a listed company’s board attempted to thwart a hostile bidder by issuing shares to a wholly-owned subsidiary and an employee stock option plan so that it could vote those shares in its own favor. Identifying a likely NYSE rule violation and agreeing that the risk of delisting presented irreparable harm, the court upheld the issuance of an injunction. While a long line of Delaware cases since Norlin has upheld poison pills under a variety of circumstances, a finding of irreparable harm based upon the risk of delisting would tilt the equities toward shareholders and possibly present a more challenging case for the board.
As currently interpreted, the 20 Percent Rule poses troubling questions for boards seeking to bolster their corporate defenses with poison pills. In considering how the 20 Percent Rule interacts with poison pills, it may be time for the exchanges to offer a new prescription.
 Nasdaq Rule 5635(d)(2).
 Id. 5635(d)(1)(A).
 Id. 5635(d)(1)(B).
 See NYSE Rule 312.03(c)(2).
 See IM-5635-3.
 Id. (emphasis added).
 Selectica’s poison pill was triggered in December 2008. See Lessons from the First Triggering of a Modern Poison Pill: Selectica, Inc. v. Versata Enterprises, Inc., Latham & Watkins (Mar. 2009), https://www.lw.com/upload/pubContent/_pdf/pub2563_1.pdf.
 For example, when Selectica triggered its poison pill, the number of shares outstanding rose from 28.7 million to 55.5 million. See Selectica Press Release, available at https://www.sec.gov/Archives/edgar/data/1090908/000095013409001161/f51267exv99w1.htm.
 See FAQs – Listings (Identification Number 383), available at https://listingcenter.nasdaq.com/Material_Search.aspx?materials=383&mcd=LQ&criteria=2&cid=16.
 See In the Matter of Lions Gate Entertainment Corp., available at https://www.sec.gov/litigation/admin/2014/34-71717.pdf.
 Norlin Corp. v. Rooney, Pace Inc., 744 F.2d 255, 267-69 (2nd Cir. 1984).
This post comes to us from Andrew G. Khanarian, a second-year student at Columbia University Law School.