In late January 2018, MSCI reopened a consultation with the investment community on the treatment of unequal voting structures. Under the MSCI’s proposal, the weights of shares with unequal voting rights in the MSCI Equity Indexes would be adjusted to reflect company level listed voting power in addition to free float. MSCI also released a discussion paper examining the theoretical and practical issues of the application of the “one share, one vote” principle. MSCI’s proposal follows the recent decisions of stock exchanges in Hong Kong and Singapore to allow dual-class voting structures in the face of increasing competition among exchanges to list companies. In contrast, in July and August 2017, S&P Dow Jones Indices and FTSE Russell excluded from some of their indices companies that have multiple voting classes.

Feedback on the MSCI’s proposal may be submitted on or before May 31, 2018 and MSCI will announce the results of the consultation on or before June 21, 2018. In the meantime, MSCI will continue to apply the temporary treatment of unequal voting structures until further notice, which does not affect any current index constituents (for more information on the temporary treatment, see our prior blog post available here).

A copy of the discussion paper is available here.

On February 12, 2018, in no-action relief granted to a mortgage REIT, the Staff of the SEC acknowledged that the real estate finance business has evolved substantially since the enactment of the Investment Company Act, with the creation and use of new debt financing techniques and mortgage-related products.  In the relief, the Staff indicates that a particular mortgage REIT’s assets, sources of income, historical development, and public representations of its policy, and the activities of its officers, directors, and employees (and other relevant factors), may evidence that the mortgage REIT is primarily engaged in the real estate finance business and, therefore, should be able to rely on the Section 3(c)(5)(C) exemption.

The Section 3(c)(5)(C) exemption generally excludes from the definition of “investment company” any entity primarily engaged in, among other things, purchasing or otherwise acquiring mortgages and other interests in real estate.  In order to qualify for this exemption, a mortgage REIT must comply with strict asset tests, including having at least 55% of its assets consist of mortgages and other liens on, or interests in, real estate that are the functional equivalent of mortgage loans (including certain mortgage-backed securities), referred to as “qualifying assets,” and at least 80% of its assets consist of qualifying assets and real estate-related assets.  Over time, the Staff has provided guidance to mortgage REITs in the form of no-action letters regarding the types of securities that it deems to be qualifying assets.

However, in this new principles-based grant of relief, the Staff focuses on the business activities of the particular issuer, instead of whether a particular asset is a qualifying asset, in determining the availability of the Section 3(c)(5)(C) exemption.  Mortgage REITs should consider obtaining confirmation from the SEC Staff regarding their own particular business activities in order to avoid any potential future uncertainty with respect to any securities held as part of the mortgage REIT’s portfolio.

For a copy of the no-action relief, please see the link below:
https://www.sec.gov/divisions/investment/noaction/2018/great-ajax-funding-021218-3c5.htm.

 

In the recently released Congressional Budget Justification, the Securities and Exchange Commission highlights a number of priorities.  In discussing the Division of Corporation Finance’s activities, the request notes that the Division remains focused on measures designed to promote capital formation.  Among these, the report notes that the Division will consider and propose amendments to modernize disclosure requirements under Regulation S-K as part of the Disclosure Effectiveness Initiative and will implement recommendations resulting from the FAST Act-mandated Regulation S-K study.  The budget request also references the Commission’s intent to “propose amendments to further facilitate capital formation through exempt and registered offerings.”  The request also refers to proposed amendments to modernize industry-specific disclosures applicable to real estate companies, including REITs.  While changes to Industry Guide 7 (mining) and Industry Guide 3 (financial institutions) have been underway, this is the first reference to changes to the REIT industry guide.  Reference is also made to the Commission’s efforts to establish the Office of the Advocate for Small Business Capital Formation.

See the request here:  https://www.sec.gov/files/secfy19congbudgjust.pdf.

Below, a continuation of our bibliography of thought-provoking articles on issues related to right-sizing regulation, staying private versus going public, and related topics:

Undue Prominence?

Lin Cheng, Darren Roulstone, and Andrew Van Buskirk consider whether the manner in which information is placed in public company disclosures influences investors’ reactions.  Their paper, “Are Investors Influenced by the Order of Information in Earnings Press Releases?” finds that generally positive information is given more prominence in press releases.  Positive information often appears first rather than being dispersed throughout a release.  The placement of the information conditions investor response.  Given the SEC’s focus on undue prominence given to non-GAAP measures now, such measures would not be emphasized at the expense of GAAP measures.  However, other information may be subject to the same approach by reporting companies.  On a positive note, the study finds that investors do not place undue reliance on the positive information emphasized by management.

Bill Hinman, Director of the Securities and Exchange Commission’s Division of Corporation Finance delivered the keynote address at the Practising Law Institute’s annual Securities Regulation in Europe program.  During his speech, Mr. Hinman touched on various topics, including the types of measures that may be undertaken in order to make the capital markets and the public company alternative more attractive.  He discussed the accommodations available to foreign private issuers (FPIs), as well as the Division’s policy changes extending the confidential submission process to companies other than emerging growth companies (EGCs).  Mr. Hinman noted that since adoption of the new policy in the summer of 2017, the Commission has received draft submissions for more than 20 IPOs of companies that exceed $1 billion in revenue or otherwise do not qualify to submit as EGCs, and from over 35 companies engaged in follow-on offerings.  Mr. Hinman also reiterated the willingness of the Division staff to review and consider requests made under Regulation S-X Rule 3-13 for accommodations relating to financial statement presentation.

Addressing future areas of focus, Mr. Hinman noted that the Staff is discussing ways in which internal processes, such as filing reviews and the consideration of no-action letter requests, as well as possible updates to the Financial Reporting Manual and the Compliance and Disclosure Interpretations in order to make these more user-friendly.  Turning to disclosure, Mr. Hinman noted that the Staff is considering whether additional guidance would be helpful regarding cybersecurity disclosure.  Mr. Hinman also provided some insight on future rulemaking.  He noted that the Staff is:

  • preparing recommendations for a proposal to implement the resource extraction issuer disclosure provision of the Dodd-Frank Act;
  • considering rulemaking to raise the threshold companies for smaller reporting company eligibility;
  • recommending final rules to update and simplify disclosure requirements that are outdated, or are overlapping or duplicative with other Commission rules or U.S. GAAP;
  • preparing recommendations for proposals to amend the rules for financial information required for acquired entities (Regulation S-X Rule 3-05), as well as Regulation S-X Rule 3-10 for disclosures by guarantors and issuers of guaranteed securities; and
  • developing recommendations for updating Industry Guide 3 to modernize the disclosure requirements for financial institutions.

The full text of Mr. Hinman’s remarks are available here:  https://www.sec.gov/news/speech/speech-hinman-020118.

PIPE transactions have provided a useful capital-raising alternative when the public markets are inhospitable.  A PIPE transaction also has become the financing of choice when it comes time to raise capital to finance an acquisition, recapitalize a company through a change-of-control transaction, or effect an orderly exit for an existing stockholder with a significant percentage ownership of the company.  We summarize the PIPE activity for 2017 in our infographic.

On January 18, 2018, the Small Business Credit Availability Act was introduced in the U.S. Senate and referred to the Committee on Banking, Housing, and Urban Affairs.  The Act would amend the Investment Company Act of 1940 to change certain requirements relating to the capital structure of business development companies (BDCs) and direct the Securities and Exchange Commission (SEC) to revise certain rules to allow BDCs to take advantage of securities offering and communication exemptions currently available to other companies.

In particular, the Act would decrease the asset coverage requirement applicable to BDCs from 200% to 150%.  BDCs would be permitted to employ leverage up to two-thirds of their total equity.  Increasing the leverage limit may allow BDCs, which are a significant source of capital for small and medium-sized businesses, to deploy additional lower risk senior capital to borrowers and potentially increase their total returns without needing to deploy higher risk junior capital in order to obtain higher yields due to the lower leverage limit.

The Act would also direct the SEC to remove the application of various securities law administrative burdens on BDCs to align with reforms currently available to other companies.  Specifically, BDCs would be included in the SEC’s definition of “well-known seasoned issuer” and permitted to file automatic shelf registration statements to expedite the securities offering process.  Additionally, BDCs that would otherwise meet the requirements of Form S-3 would be permitted to incorporate by reference their publicly filed periodic reports into the BDC’s Form N-2 registration statement.

The Act will be considered by the Committee before it is possibly sent to the full Senate for review.  A companion bill that would similarly update rules governing BDCs was advanced with bipartisan support by the U.S. House Financial Services Committee in November 2017.

As we have previously discussed on our blog, the securities exchanges impose shareholder vote requirements in connection with certain financing transactions.  These rules are often referred to as the “20% Rule,” since, for Nasdaq, for example, a shareholder vote is required to be obtained by a listed company that intends to complete certain private placement transactions that will result in the issuance of 20% or more of the total pre-transaction voting shares outstanding.   We discuss these rules in our recently updated FAQs (see: https://goo.gl/aagwaA).

Recently, Nasdaq filed with the SEC an amendment that would update certain of these rules.  Nasdaq had solicited comments on these changes (see our prior post from the summer (available here: https://goo.gl/i156t5).  The proposal would, among other things:

  • amend the measure of “market value” in connection with assessing whether a transaction is being completed at a discount from the closing bid price to the lower of:  the closing price as reflected by Nasdaq, or the average closing price of the common stock for the five trading days preceding the definitive agreement date;
  • refer to the above price as the “Minimum Price,” and existing references to “book value” and “market value” used in Rule 5635(d) will be eliminated; and
  • eliminate the references to “book value” for purposes of the shareholder vote requirement.

See the full text of the amendments here: https://goo.gl/vswnxc.

On February 2, 2018, the SEC approved on an accelerated basis the NYSE’s proposal, as modified by Amendment No. 3, to change its listing qualifications to facilitate listings for certain non-IPO offerings.  Section 102.01B of the NYSE Listed Company Manual (“Section 102.01B”) currently recognizes that some companies that have not previously registered their common equity securities under the Exchange Act, but which have sold common equity securities in a private placement, may wish to list those common equity securities on the NYSE at the time of effectiveness of a resale registration statement filed solely for the resale of the securities held by selling stockholders.  Footnote (E) of Section 102.01B (“Footnote (E)”) currently provides that the NYSE will exercise its discretion to list these companies by determining that a company has met the $100 million aggregate market value of publicly-held shares requirement based on a combination of both (1) an independent third-party valuation of the company and (2) the most recent trading price for the company’s common stock in a trading system for unregistered securities operated by a national securities exchange or a registered broker-dealer (a “Private Placement Market”).

The proposal, as modified by Amendment No. 3 filed on December 8, 2017: (i) eliminates the requirement in Footnote (E) to have a private placement market trading price if there is a valuation from an independent third-party of $250 million in market value of publicly-held shares; (ii) sets forth several factors indicating when the independent third party providing the valuation would not be deemed “independent” under Footnote (E); (iii) amends NYSE Rule 15 to add a reference price for when a security is listed under Footnote (E); (iv) amends NYSE Rule 104 to specify Designated Market Maker (“DMM”) requirements when facilitating the opening of a security listed under Footnote (E) when there has been no sustained history of trading in a private placement trading market for such security; and (v) amends NYSE Rule 123D to specify that the NYSE may declare a regulatory halt prior to opening on a security that is the subject of an initial pricing upon NYSE listing and that has not, immediately prior to such initial pricing, traded on another national securities exchange or in the over-the-counter market.

However, Amendment No. 3 notably revises the proposal, as amended by Amendment No. 2 filed on August 16, 2017, to eliminate proposed changes to Footnote (E) that would have allowed a company to undertake a direct listing (i.e., listing immediately upon effectiveness of an Exchange Act registration statement only, such as Form 10 or Form 20-F, without any concurrent IPO or Securities Act registration).  This means that a direct listing will now require a company to either (1) file a resale registration statement for the resale from time to time of securities held by existing securityholders or (2) undertake a primary offering.  Although this may limit the efficiency of a direct listing, the rationale for the change might be to ensure that there is a basis for Securities Act Section 11 liability to attach to the direct listing.  In contrast, Nasdaq allows a direct listing without a concurrent IPO or Securities Act registration.

As we have previously posted on, the NYSE originally issued its proposal on March 13, 2017, which was later withdrawn on July 19, 2017 and then amended by Amendment No. 1 on July 31, 2017.  The SEC has solicited comments on the proposal, as amended by Amendment No. 3, for submission within 21 days of publication in the Federal Register.

The SEC order is available here.

The proposal, as amended by Amendment No. 3, is available here.

Citibank’s recently released year-end report on depositary receipts (DR) reported that in 2017, $15.6 billion of DR capital was raised across 65 deals, which was a 126% year-over-year change in total capital raised versus 2016 and a 91% year-over-year change in number of capital raisings. The European, Middle East and Africa region saw a total of 28 deals, raising $4.4 billion; the Asia-Pacific region raised $7.0 billion across 29 deals; and the Latin America region raised $4.2 billion across 8 deals.

The report also notes that DR IPOs raised $9.4 billion in 2017, which was a 145% change from 2016.  24 issuers were able to take advantage of JOBS Act accommodations to complete their IPOs.  There was also $6.2 billion of DR follow-on activity in 2017, which was a 101% change from 2016.  $12.8 billion was raised in American depositary receipts (ADR) and $2.8 billion was raised in global depositary receipts (GDR).

The energy, software and services and the financial services sectors were the top three sectors for DR IPOs in 2017 raising $1.57 billion, $1.54 billion and $1.48 billion respectively.  For follow-on offerings, the top three sectors included financial services, raising $1.87 billion, pharmaceuticals/biotech, raising $1.43 billion, and software and services, raising $681 million.

For additional 2017 DR trends, see Citi’s annual report: https://depositaryreceipts.citi.com/adr/common/file.aspx?idf=4354