SEC expedites SRO rule change procedures and some changes to Nasdaq rules

By Cydney Posner

The SEC has posted final rules and new interpretive guidance to improve and expedite the rulemaking process for exchanges and other self-regulatory organizations (SROs) that operate under SEC oversight. These rules were adopted at an open meeting on June 25, 2008. Under the Exchange Act, SROs are required to file their proposed rule changes with the SEC for review and approval. When a proposed rule change is submitted, the SEC must approve it or institute proceedings to disapprove it within 35 days of its publication, subject to extension for up to 90 days in certain cases. Increasing global competition among exchanges has created pressure on exchanges to adapt quickly, sometimes requiring prompt rule modifications. To address delays in rule processing, the SEC has proposed to amend its internal rules of procedure to require that any proposed SRO rule change be published within 15 business days, subject to exception in the event of unusually complex or novel issues, as determined by the Director of the Division of Trading and Markets. Some proposed rule changes (such as those relating to interpretations of existing rules or changes that do not impose an additional burden) may be deemed to be "non-controversial" and, therefore, become effective immediately (although these rules may be later abrogated by the SEC). In this release, the SEC has issued new interpretive guidance designed to expand the types of proposed rule changes that may properly be filed for immediate effectiveness as "non-controversial" rule changes because they do not significantly affect the protection of investors or the public interest and do not impose any significant burden on competition.

And speaking of SROs, Nasdaq has proposed to modify its definition of "independence" for the purpose of determining whether a director is deemed to be independent. Currently, Nasdaq’s rules generally preclude a director from being considered independent if, among other things, the director has received more than $100,000 in compensation from the issuer. Nasdaq proposes to increase that threshold to $120,000 to conform to the threshold set forth under Reg S-K Item 404(a). Because the disclosure threshold is $120,000, Nasdaq believes that using a consistent standard would enhance Nasdaq’s ability to assess compliance with the independent director requirements because transactions involving amounts between $100,000 and $120,000 may not be disclosed. In addition, Nasdaq believes that its rules should be consistent with the NYSE rules (which have apparently also been proposed to be amended) regarding the definition of an independent director.

In mid-June, the SEC approved another Nasdaq proposal to modify the initial and continued listing standards regarding the minimum number of round lot holders necessary to demonstrate the security’s liquidity. The new rule modifies the requirement of round lot holders, as well as provides new definitions with respect to these changes.

The prior minimum requirement for initial listing under the Nasdaq Global Select Market was: (1) a minimum of 550 beneficial holders and average monthly trading volume over the previous 12 months of at least 1,100,000 shares per month; (2) a minimum of 2,200 beneficial holders; or (3) a minimum of 450 beneficial round lot holders. Nasdaq has changed this requirement to: (1) a minimum of 550 "total" shareholders and average monthly trading volume over the previous 12 months of at least 1,100,000 shares per month; (2) a minimum of 2,200 "total" shareholders; or (3) a minimum of 450 "round lot holders." Nasdaq has also added a new definition of "total holders," which includes beneficial holders and holders of record and amended the definition of "round lot holder" to clarify that beneficial holders are to be considered in addition to holders of record. The NYSE also uses the concept of "total" shareholders.

The prior minimum requirement for continued listing under the Nasdaq Global Select Market and Nasdaq Global Market was 400 round lot holders for common stock and equivalent and 100 round lot holders for preferred stock and secondary classes of common stock. Nasdaq has changed this requirement to 400 "total" shareholders for common stock and equivalent and 100 "public" shareholders for preferred stock and secondary classes of common stock. The prior minimum requirement for continued listing for domestic securities on the Nasdaq Capital Market was 300 round lot holders for common stock and 100 round lot holders for preferred stock and secondary classes of common stock. Nasdaq has changed this requirement from "round lot holders" to "public holders." Nasdaq has also defined "public holders" to include beneficial holders and holders of record and to exclude any holder who is, either directly or indirectly, an executive officer, director or the beneficial holder of more than 10% of the total shares outstanding.

The SEC has also approved a proposed Nasdaq rule change to modify Nasdaq’s notification process for listing of additional shares . These notification requirements are intended to allow Nasdaq to make compliance determinations regarding stock issuances that are potentially subject to the shareholder approval rules.

First, Nasdaq has clarified the timing of the notice requirement contained in Rules 4310(c)(17)(D) and 4320(e)(15)(D). Previously, the rules required that these notifications were required prior to "entering into" a transaction that may result in the potential issuance of common stock (or securities convertible into common stock) greater than 10% of either the total shares outstanding or the voting power outstanding on a pre-transaction basis. However, in practice, Nasdaq has permitted companies to file the required notification 15 days before issuing the securities, rather than 15 days prior to entering into the transaction (which may not even be possible in some cases where transactions are signed in fewer than 15 days). The revision conforms the rule to actual practice by making clear that notice will instead be required prior to "issuing" the securities. The change was designed to provide issuers certainty as to the latest point in a transaction when notification can be provided under Nasdaq’s rule, as well as to eliminate any ambiguity surrounding the application of this rule.

Second, Nasdaq has modified the notice requirement contained in Rules 4310(c)(17)(A) and 4320(e)(15)(A) relating to the exception to shareholder approval for inducement grants to new employees. Previously, the rule provided that an issuer was required to notify Nasdaq at least 15 calendar days prior to establishing or materially amending a stock option plan, purchase plan or other equity compensation arrangement pursuant to which stock may be acquired by officers, directors, employees or consultants without shareholder approval. However, because inducement grants can be made at the time the employment offer is accepted, companies may not be able to provide 15 days' advance notice. Therefore, Nasdaq has modified the rule to require notification of inducement grants no later than the earlier of: (1) five calendar days after entering into the agreement to issue the securities; or (2) the date of the public announcement of the award required by Rule 4350(i)(l)(A)(iv).

Third, Nasdaq has amended Rules 4310(c)(17) and 4320(e)(15) to clarify that the notifications required by these rules must be made on a Listing of Additional Shares ("LAS") Notification Form and that Nasdaq encourages companies to file the form as soon as practicable. In addition, to provide transparency regarding the consequences of failing to timely file LAS notifications, Nasdaq has amended the rules to specifically state that if a company fails to timely file the LAS notification, Nasdaq may issue a public reprimand letter or a delisting determination. In making that decision, Nasdaq would consider whether the issuer has demonstrated a pattern of late filings, the length of the filing delays, the reason for the delays, whether the issuer has been contacted concerning previous violations, whether the underlying transactions were themselves non-compliant and whether the issuer has taken steps to assure that future violations will not occur.

This content is provided for general informational purposes only, and your access or use of the content does not create an attorney-client relationship between you or your organization and Cooley LLP, Cooley (UK) LLP, or any other affiliated practice or entity (collectively referred to as “Cooley”). By accessing this content, you agree that the information provided does not constitute legal or other professional advice. This content is not a substitute for obtaining legal advice from a qualified attorney licensed in your jurisdiction and you should not act or refrain from acting based on this content. This content may be changed without notice. It is not guaranteed to be complete, correct or up to date, and it may not reflect the most current legal developments. Prior results do not guarantee a similar outcome. Do not send any confidential information to Cooley, as we do not have any duty to keep any information you provide to us confidential. This content may be considered Attorney Advertising and is subject to our legal notices.