SEC Approves Nasdaq Rule Change Allowing Direct Listings with a Capital Raise
By: Ran Ben-Tzur , Jennifer J. Hitchcock
[Editor's Note (1/25/22): This article includes an update regarding the amended rule proposal Nasdaq filed with the SEC in January 2022.]
[Editor's Note (6/1/21): This article includes an update regarding a proposed rule change by Nasdaq to its recently approved rules on Direct Listings with a Capital Raise.]
In our prior article on the latest and greatest in direct listings, we noted that we were expecting that Nasdaq would follow the NYSE’s lead to allow for capital raising concurrently with a direct listing. On May 19, 2021, and after a number of back-and-forth proposals, the U.S. Securities and Exchange Commission approved a proposed Nasdaq rule change to allow for capital raising concurrently with a direct listing on the Nasdaq Global Select Market.
In addition to a direct listing where only existing stockholders offer their shares for resale to the public, the new Nasdaq rules will allow companies to raise primary capital at the time of the direct listing. Nasdaq refers to this new type of offering as a “Direct Listing with a Capital Raise.” This gives companies flexibility to raise capital in a direct listing on both Nasdaq and NYSE.
To qualify for a Direct Listing with a Capital Raise, the company’s unrestricted publicly held shares before the offering, plus the market value of the shares to be sold by the company in the direct listing must be at least $110 million (or $100 million, if the company has stockholders’ equity of at least $110 million), with the value of the unrestricted publicly held shares and the market value being calculated using a price per share equal to the lowest price of the price range established by the company in its S-1 registration statement.
Any company conducting a Direct Listing with a Capital Raise would also have to meet all of Nasdaq’s other initial listing requirements, including the requirement to have 450 round lot stockholders (stockholders that hold more than 100 shares) with at least 50% of such round lot holders each holding unrestricted securities with a market value of at least $2,500 and 1.25 million publicly held shares outstanding at the time of listing. While compliance with these requirements is oftentimes a foregone conclusion in a traditional initial public offering (IPO), a lack of a grace period for compliance with these requirements in a direct listing, specifically from the round lot requirements, will make it difficult for many companies to pursue the direct listing option, including a Direct Listing with a Capital Raise. One way a company can add additional stockholders to meet the round lot requirements is to release transfer restrictions in advance of the direct listing.
It is important to remember that the “reference price” in a direct listing is merely a directional indicator to the market for where the stock might trade on the first day of trading. No shares actually trade hands at the reference price—it is simply a starting point for the price-discovery process.
For a direct listing without a capital raise and where the company does not have a sustained private placement market for its shares prior to listing, the reference price is determined by the exchange in consultation with the company’s financial advisors. There is no specific formula for determining the reference price. To determine the reference price, the exchange and financial advisors look at a variety of factors, including recent secondary trades on the private market, comparable public companies and reports from a company’s independent valuation provider. The company is not allowed to participate in the reference price determination.
Just like a traditional IPO, in a Direct Listing with a Capital Raise, a company would be issuing new shares and would be required to disclose a price range for the shares on the cover in its S-1 registration statement. For a Direct Listing with a Capital Raise, the reference price is the lowest price of the price range set forth in its S-1 registration statement.
As noted above, a Direct Listing with a Capital Raise would allow the company to sell shares in the opening auction on the first day of trading on the exchange. To effectuate this, Nasdaq introduced a new order type for a Direct Listing with a Capital Raise called a Company Direct Listing Order (CDL Order). While there are many granular details about the CDL Order in the final rules, the most important ones are that the CDL Order is a market order which is entered without a price so the price will be determined by the Nasdaq Halt Cross, or the opening auction, and (1) the price must be at or above the lowest price and at or below the highest price of the price range set forth in the company’s S-1 registration statement; and (2) the full quantity of the order (i.e., the total number of shares that the company seeks to sell in the Direct Listing with a Capital Raise) must be sold within that price range. If there is insufficient buying interest and Nasdaq is not able to price the auction to satisfy the CDL Order, and all other market orders priced better than the price determined by Nasdaq, the shares would not begin trading.
The proposal approved by the SEC differs from the original proposal submitted by Nasdaq for a primary direct listing in August 2020. In its original proposal, Nasdaq sought to provide greater flexibility than the price range set forth in the company’s S-1 registration statement. Under Nasdaq’s original proposal, a primary direct listing would have been permitted to proceed as long as the price determined in the opening auction was equal or greater to 20% below the lowest price in the price range disclosed in the company’s S-1 registration statement and also would have allowed the company to calculate compliance with the listing requirements based on that same price. Following concerns expressed by the SEC with this approach in December 2020, Nasdaq amended its proposal. While the greater flexibility Nasdaq originally sought with respect to the pricing of the Direct Listing with a Capital Raise was not included in the amended proposal which has been approved by the SEC, Nasdaq has indicated that it intends to file a separate proposal which would include this flexibility in pricing.
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On May 25, 2021, Nasdaq filed a rule proposal with the SEC to modify the price range limitation described in the alert above for increased price flexibility. Under the proposal, a Direct Listing with a Capital Raise would be permitted to be executed in the opening auction at a price that is at or above the price that is 20% below the lowest price and at or below the price that is 20% above the highest price of the price range established by the company in its S-1 registration statement.
In addition, in the event that the company has certified to Nasdaq that such price would not materially change the company’s previous disclosure in its S-1 registration statement, Nasdaq would permit the price in the opening auction to be at a price above the price that is 20% above the highest price in the price range established by the company in its S-1 registration statement. Under the proposed rule, the 20% threshold would be calculated using the high end of the price range in the company’s effective S-1 registration statement and may be measured from either the high end (in the case of an increase in the price) or low end (in the case of a decrease in the price) of that range.
Further, the value of the unrestricted publicly held shares before the offering and the market value of the shares to be sold by the company in the direct listing would be calculated using a price per share equal to the price that is 20% below the lowest price of the price range disclosed by the company in its S-1 registration statement rather than using a price per share equal to the lowest price of the price range based on the rationale that this would be the minimum price at which the company could be listed.
Nasdaq has indicated that the rule proposal is intended to mitigate the reluctance it believes companies and their advisors may have regarding the use of the Direct Listing with a Capital Raise method of going public as compared to a traditional initial public offering, since the pricing of a traditional initial public offering is not subject to similar price range limitations. Given the concerns the SEC expressed with respect to Nasdaq’s original proposal in August 2020, it will be interesting to see if the SEC allows for this increased pricing flexibility. We will continue to monitor for further developments.
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On January 6, 2022, Nasdaq filed an amended rule proposal with the U.S. Securities and Exchange Commission to address the SEC’s questions and concerns related to the prior proposal filed by Nasdaq on May 25, 2021, which sought increased pricing flexibility in a Direct Listing with a Capital Raise.
Among other things, the amended proposal includes additional requirements for pricing a Direct Listing with a Capital Raise at more than 20% above the price range, adds certain notification requirements and a price volatility constraint, eliminates market orders (other than by the company) from the opening of the offering, requires a company to specify the quantity of shares registered in the S-1 registration statement and aligns the 20% price range deviation calculation with the SEC’s rules.
Additional Requirements for Pricing a Direct Listing with a Capital Raise at More than 20% above the Price Range. In order for investors to better understand how changes in share price impact critical elements of the disclosure, the amended proposal adds a requirement that in order for a company to price a Direct Listing with a Capital Raise at more than 20% above the price range included in the S-1 registration statement, the S-1 registration statement must contain a sensitivity analysis disclosing how the company’s plans for the proceeds from the offering would change if the actual proceeds of the offering exceeded the amount assumed in the price range included in the S-1 registration statement.
The amended proposal also introduces a “Post-Pricing Period” where if the actual price calculated by the Nasdaq Halt Cross is above the price that is 20% above the highest price of the price range established by the company in the S-1 registration statement, Nasdaq will initiate a brief Post-Pricing Period following the calculation of the actual price. In instances where the Post-Pricing Period is triggered, the company must confirm to Nasdaq during this time that no additional disclosures are required under federal securities laws based on the actual price. During this period, no additional orders may be entered and no existing orders may be modified. The Post-Pricing Period will end and the shares will be released for trading immediately after the company provides such confirmation to Nasdaq. However, in the event the company cannot provide the required confirmation, Nasdaq will postpone and reschedule the offering.
Notifications and Price Volatility Constraint. In an effort to enhance price discovery transparency, under the amended proposal, Nasdaq proposes to disseminate, free of charge, the current reference price, on a public website, such as Nasdaq.com, during the pre-launch period of the offering and to indicate whether it is within the price range established by the company in the S-1 registration statement.
The amended proposal adds a new price volatility constraint which requires that the current reference price has not deviated by 10% or more from any current reference price within the previous 10 minutes. Under the amended proposal, the pre-launch period will continue until the price volatility constraint has been satisfied and Nasdaq will disseminate information about whether the constraint has been satisfied.
The amended proposal also adds Nasdaq member notification requirements. Nasdaq will provide specified information to Nasdaq members in advance of any Direct Listing with a Capital Raise, including describing any special characteristics of the offering and the Nasdaq rules applicable to the offering, and Nasdaq members will be required to provide to a customer, before that customer places an order to be executed in the Cross, a notice describing the mechanics of pricing a security subject to a Direct Listing with a Capital Raise, including information regarding the location of the public website where Nasdaq will disseminate the current reference price.
Elimination of Market Orders. The amended proposal would prohibit market orders (other than by the company) from the opening of a Direct Listing with a Capital Raise in order to assure that investors only purchase shares at a price at or better than the price they affirmatively set, after having the opportunity to review the company’s S-1 registration statement, including the sensitivity analysis describing how the company will use any additional proceeds raised.
Quantity of Registered Shares. The amended proposal adds a requirement that the company must specify the quantity of shares registered in the S-1 registration statement.
Calculation of 20% Price Deviation. The amended proposal provides that the 20% threshold for a 20% deviation from the low or high end of the price range included in the S-1 registration statement would be calculated based on the maximum offering price set forth in the S-1 registration statement fee table, consistent with Rule 430A of the Securities Act of 1933, as amended.
The comment period for Nasdaq’s amended rule proposal will run until February 2, 2022, and the SEC will make a final decision on the proposal by February 25, 2022.