Arnold & Porter Discusses SEC Approval of NYSE Direct Listings Proposal

The SEC has given the New York Stock Exchange (NYSE) clearance to allow companies to raise capital in connection with a direct listing on the NYSE. A direct listing is an alternative to a traditional underwritten IPO that allows a private company to list its equity securities without an underwritten offering. The NYSE and The Nasdaq Stock Market (Nasdaq) both currently permit companies to directly list shares held by pre-IPO stockholders, such as employees and early stage investors, without an underwritten offering. The NYSE’s rule amendment adds a new type of direct listing that will permit a private company to list its common stock on the NYSE at the time of effectiveness of a registration statement pursuant to which the issuer itself will sell common stock to the public for cash in an opening auction on the first day of trading. The SEC approved the NYSE rule changes on August 26, 2020.

Which Companies are Likely to Find a Primary Direct Floor Listing Attractive?

The NYSE’s rule change will make a direct listing an option for those companies that are not only seeking liquidity for existing stockholders but also seeking to raise capital as part of their initial listing. While many companies are attracted to the advantages of a direct listing—including the ability to allow the market to set the opening auction price, potentially lower costs and the lack of a 180-day underwriters’ lockup for insiders—until now, direct listings have not been an option for companies for which raising capital is a primary goal in going public. This is arguably a game changer for some companies that have not previously considered a direct listing.

Unfortunately, the universe of companies for which direct listing will be an option may continue to be limited by the requirement that a company meet all listing standards at the time of listing, without the benefit of a grace period. For example, the NYSE’s initial listing standards include a requirement that the company have a minimum of 400 round lot holders. With the exception of widely-held private companies for which there is already trading in a private market, many pre-IPO companies will not meet this requirement. Direct listings may in any event continue to be better suited to larger companies that are already known to investors, such as Spotify and Slack Technologies. With a direct listing, the company forgoes a traditional road show, book building process and price stabilization in favor of company-led marketing efforts. Smaller, less well-known issuers may find a direct listing difficult to navigate successfully.

In addition, the stock exchanges’ direct listing rules do not apply to listings of special purpose acquisition companies (SPACs). SPACs would likely, in any event, be unable to meet the other initial listing standards at the time of listing given their limited pre-IPO ownership.

Direct Offerings–Primary Direct and Selling Shareholder Direct Floor Listings

As a result of the rule change, the NYSE now permits both “Primary Direct Floor Listings” and “Selling Shareholder Direct Listings.” Both types of direct listings allow initial listing by a company in connection with the effectiveness of registration statement with the distinction being whether the company is selling stock in the opening auction or whether the registration statement is solely to allow existing stockholders to sell their shares.

Initial Listing Standards for Primary Direct Floor Listings and Selling Shareholder Direct Floor Listings

The NYSE’s initial listing standards require that an issuer have a minimum of $100 million in aggregate market value of publicly-held shares (Public Market Value) in connection with a direct listing. The rule changes specify that, in connection with a Primary Direct Floor Listing, the Public Market Value test will be met if the issuer is selling at least $100 million in market value in the opening auction. If not, then the issuer must meet a higher $250 million Public Market Value test based on the combined market value of the pre-IPO publicly-held shares and the shares sold in the opening auction, with the market value calculated using the low end of the price range set forth in the issuer’s effective registration statement.

These thresholds are similar to those currently in place for a Selling Shareholder Direct Listing. The NYSE has not amended the manner in which it determines whether the $100 million Public Market Value test is met for Selling Shareholder Direct Floor Listings. The NYSE will continue attribute a market value equal to the lesser of: (i) the value calculable based on an independent third party valuation; and (ii) the value calculable based on the most recent trading price in a “Private Placement Market” (defined as a trading system for unregistered securities operated by a national securities exchange or a registered broker-dealer). In the absence of any recent trading in a Private Placement Market, the NYSE will determine that a company has met the Public Market Value test only if the company provides a valuation evidencing a Market Value of at least $250 million.

In contrast, the NYSE’s listing standards for traditional underwritten offerings is $40 million in Public Market Value. The higher thresholds for direct listings are intended to provide assurance that there will be a sufficiently liquid trading market notwithstanding the absence of an initial underwritten distribution.

Summary of NYSE Listing Standards Applicable to Direct Listings

The following summarizes the methods of complying with the Public Market Value initial listing standard.

Listing Standard Selling Shareholder Direct Floor Listing Primary Direct Floor Listing
Minimum Public Market Value (excludes shares held by officers, directors and persons owning 10%+ of the common stock) $100 million of pre-IPO publicly-held shares, based on the lesser of (i) value calculable based on independent third party valuation and (ii) value calculable based on recent trading prices in Private Placement Market. Standard met if company sells at least $100 million in market value in opening auction
If no recent trading in Private Placement Market, company must provide an independent valuation of pre-IPO publicly-held shares of at least $250 million. If company sells less than $100 million in market value, aggregate market value of pre-IPO publicly-held shares and shares sold by the company in opening auction must total at least $250 million (based on low end of price range in the registration statement).

Issuer Direct Offering Orders and Opening Auction Mechanics

As with a traditional IPO, an issuer selling securities in an opening auction must establish a price range at which it will offer the securities and set forth the price range in its registration statement. The Primary Direct Floor Listing will be effected through an Issuer Direct Offering Order, or “IDO,” issued by the company. The IDO Order will be a “limit order,” meaning that the IDO Order will be completed only if the issuer is able to sell the full number of shares specified in the registration statement within the price range specified in the registration statement.  The new rules provide that an IDO Order cannot be cancelled or modified. If the IDO Order cannot be executed in full within the price range specified in the registration statement, all orders will be cancelled.

The responsibility for determining whether an auction can proceed lies with the designated market maker (“DMM”). The DMM is responsible for setting the Auction Price, which is the opening price in the auction. If there is insufficient buy interest to satisfy both the IDO Order and all “better priced” sell orders (those placed at a price lower than the Auction Price), the DMM will not conduct the auction. In determining whether all of the shares being offered by the issuer in the auction can be sold within the price range, the DMM will give priority to any shares sought to be sold by selling shareholders at prices lower than the Auction Price. However, if the Auction Price is equal to the low end of the range specified in the registration statement, priority will be given to the company’s IDO Order to increase the likelihood that the IDO Order can be executed in full and the direct listing can proceed.

Compliance Required with All Initial Listing Rules at the Time of Listing without Grace Period

The SEC did not approve the NYSE’s proposal to allow companies additional time to meet its initial listing distribution standards. As a result, companies listing through a Primary Direct Floor Listing or a Selling Shareholder Direct Listing must still meet all other initial listing requirements at the time of the initial listing, including the requirements that the company have a minimum of 400 round lot holders, 1.1 million publicly-held shares outstanding and a price per share of at least $4.00.

The NYSE had previously proposed to grant certain companies a grace period of up to 90 trading days from the date of initial listing to comply with the applicable initial listing distribution requirements. Specifically, a company would have been entitled to the grace period if it either sold at least $250 million in market value of shares in connection with a Primary Direct Floor Listing or had at least $350 million in Market Value, including shares outstanding prior to the listing. The SEC raised a significant number of issues with the proposed grace period, including concerns that a company could trade for an extended period of time without demonstrating compliance with the initial standards and that the failure to come into compliance could result in the delisting of newly listed companies. In response to these concerns, the NYSE subsequently removed the proposed grace period and resubmitted an amended proposal to the SEC.

The requirement that companies conducting a direct listing meet all exchange listing requirements at the time of initial listing may limit the issuers for whom direct listing will be possible.  As the NYSE noted in its original rule proposal, private companies generally do not have 400 round lot holders. The round lot holder requirement is generally not an issue in a traditional IPO because the underwriters distribute the shares sold in the IPO to a sufficient number of accounts to meet the stock exchanges’ initial listing requirements.

NASDAQ Proposal for Direct Listings with a Capital Raise

Nasdaq filed its own rule proposal with the SEC on August 24, 2020 to permit a “Direct Listing with a Capital Raise,” which would permit issuers to conduct primary offerings in connection with a direct listing. Nasdaq’s proposed rule is similar in many respects to the NYSE proposal but would not require that the opening price be within the price range set forth in the registration statement. Instead, Nasdaq proposes to allow companies to initiate listing at a price up to 20% below the low end of the price range in the company’s registration statement and Nasdaq will not require a ceiling. In calculating whether a company satisfies Nasdaq’s Market Value of Unrestricted Publicly Held Shares requirement, Nasdaq will calculate the value of the shares using the price that is 20% below the low end of the price range and will deem the test to be met if the aggregate market value of unrestricted publicly-held shares immediately prior to listing, together with the value of the shares the issuer sells in the opening auction, is at least $110 million (or $100 million, if the company has stockholders’ equity of at least $100 million).

This post comes to us from Arnold & Porter Kaye Scholer LLP. It is based on the firm’s memorandum, “SEC Approves NYSE Proposal to Permit Direct Listings Through Primary Offerings; Nasdaq Proposes to Follow Suit,” dated August 26, 2020, and available here.

1 Comment

  1. Gregory Clapp

    Thank you. With respect to the NASDAQ proposal’s Market Value of Unrestricted Publicly Held Share’s requirement, can you provide the definition of “unrestricted publicly-held” shares?

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