Nasdaq’s Change of Control Rule – Does It Apply in a Public Offering?

Tax inspector investigating financial documents through magnifyiBy Kevin Friedmann

Are you concerned about whether Nasdaq’s change of control rule will limit the size of  your public offering? According to the Nasdaq staff, you don’t need to worry about this, as long as you have a bona fide public offering.

Nasdaq Listing Rule 5635(b) provides that shareholder approval is required prior to the issuance of securities when the issuance or potential issuance will result in a change of control of the company. According to Nasdaq, a change of control would occur when, as a result of the issuance, an investor or a group would own, or have the right to acquire, 20% or more of the outstanding shares of common stock or voting power and such ownership or voting power would be the largest ownership position (the “Change of Control Rule”). See Nasdaq FAQ ID#195.

Nasdaq Listing Rule 5635(d) provides that shareholder approval is required for the issuance 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 “Private Placement Rule”). Under the Private Placement Rule, however, shareholder approval is not required for a “public offering.”

We recently faced the question of whether the Change of Control Rule could limit the size of a company’s public offering, because the Change of Control Rule, as written, does not exempt public offerings, whereas the Private Placement Rule does specifically exempt public offerings. Several institutional shareholders of the company planned to participate in the public offering, and one of them would likely become a 20% or greater shareholder (and the new largest shareholder) as a result. If the Change of Control Rule were to apply, then the size of the offering would be limited to 19.99% of the company’s outstanding shares. This would mean cutting the desired offering size in half! So, the answer to our question would have a dramatic impact on the company.

Given the absence of any Nasdaq FAQ or Staff Interpretation Letter on point [1], we called the Nasdaq staff to ask the following:

Question: Does Nasdaq apply the Change of Control Rule to a public offering?  

Answer: No. According to the Nasdaq staff, Nasdaq’s policy is to not apply the Change of Control Rule to any “public offering” that meets the requirements for a public offering under IM-5635-3.

“IM-5635-3. Definition of a Public Offering

Rule 5635(d) provides that shareholder approval is required for the issuance of common stock (or securities convertible into or exercisable for common stock) equal to 20 percent or more of the common stock or 20 percent or more of the voting power outstanding before the issuance for less than the greater of book or market value of the stock. Under this rule, however, shareholder approval is not required for a “public offering.”

Companies are encouraged to consult with Nasdaq staff in order to determine if a particular offering is a “public offering” for purposes of the shareholder approval rules. Generally, a firm commitment underwritten securities offering registered with the Securities and Exchange Commission will be considered a public offering for these purposes. Likewise, any other securities offering which is registered with the Securities and Exchange Commission and which is publicly disclosed and distributed in the same general manner and extent as a firm commitment underwritten securities offering will be considered a public offering for purposes of the shareholder approval rules. However, Nasdaq staff will not treat an offering as a “public offering” for purposes of the shareholder approval rules merely because they are registered with the Commission prior to the closing of the transaction.

When determining whether an offering is a “public offering” for purposes of these rules, Nasdaq staff will consider all relevant factors, including but not limited to:

(i) the type of offering (including whether the offering is conducted by an underwriter on a firm commitment basis, or an underwriter or placement agent on a best-efforts basis, or whether the offering is self-directed by the Company);

(ii) the manner in which the offering is marketed (including the number of investors offered securities, how those investors were chosen, and the breadth of the marketing effort);

(iii) the extent of the offering’s distribution (including the number and identity of the investors who participate in the offering and whether any prior relationship existed between the Company and those investors);

(iv) the offering price (including the extent of any discount to the market price of the securities offered); and

(v) the extent to which the Company controls the offering and its distribution.

Adopted Mar. 12, 2009 (SR-NASDAQ-2009-018).”

Practitioners should be comforted by Nasdaq’s stated internal policy that the Change of Control Rule does not apply to a “public offering”, but it would be helpful for Nasdaq to publish an FAQ along the lines presented above so that companies can easily dispense with this worrying question when planning a public offering.

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[1] There is a Staff Interpretation Letter (2004-38), published July 31, 2012, which contains the following sentence: “In accordance with NASDAQ’s shareholder approval requirements, shares issued in a public offering are not subject to shareholder approval.” However, this is in response to a question about whether the Private Placement Rule (not the Change of Control Rule) applied to a particular transaction. The only reference to the Change of Control Rule in that Staff Interpretation Letter is about whether the Change of Control Rule applies to open market purchases, which it does not.

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