December 23, 2020
Authored by: R. Randall Wang and Rob Endicott
Yesterday, by another 3-2 vote, the SEC approved changes to NYSE listing rules relating to primary direct listings after conducting a “de novo” review following objections raised by certain investors and commentators.
In August, using delegated authority, the SEC’s Division of Trading and Markets had approved changes to NYSE listing rules to allow companies to raise capital in connection with a direct listing on the NYSE without a firm commitment offering. Shortly afterwards, the SEC notified the NYSE that the rule changes had been stayed following receipt of notice from the Council of Institutional Investors (CII) that the CII was submitting a petition for a full Commission review of the delegated approval by the Division.
The Commission conducted a de novo review, considering the CII petition and comments submitted. The majority decided to affirm the rule change – described in our earlier post – as consistent with applicable law. The CII’s principal concerns, which were shared by Commissioners Lee and Crenshaw, related to:
- The lack of an underwriter and corresponding due diligence, resulting in reduced investor protection
- The reduced ability for shareholders to recover damages for false or misleading disclosures, due to the judicial doctrine of “traceability,” under which courts have held that plaintiffs lack standing to pursue claims if they cannot trace their purchased shares back to the offering covered by the registration statement
In response to these concerns, the SEC majority concluded:
- Primary direct listings will be registered under the Securities Act and subject to the existing liability and disclosure framework
- The Securities Act does not require involvement of an underwriter in registered offerings
- A financial advisor engaged by an issuer for a direct listing may be deemed a statutory underwriter, creating incentive to conduct due diligence in order to address reputational and potential liability concerns
- The absence of an underwriter does not preclude investors from pursuing claims for false or misleading offering documents or affect the amount of recoverable damages
- The roles of issuers, officers, directors and accountants in assuring proper disclosures remain in place
- The liability concerns arising from the “traceability” doctrine are not exclusive or necessarily inherent in primary direct listings, and arise whenever outstanding shares trade in the same market as those registered in an offering
- The doctrine is judicially created, dependent on particular facts and circumstances and can vary by judicial district, and likely to continue to evolve
- No case in the direct listing context has been identified prohibiting plaintiffs from pursuing Section 11 claims
- Tracing challenges are not expected to be of such magnitude as to render the proposal inconsistent with the Exchange Act
- Primary direct listings will provide benefits to investors, including:
- Some investors who would not receive allocations in a traditional IPO may be able to purchase shares at the original auction price in a primary direct listing rather than in aftermarket trading, potentially broadening the scope of investors in IPOs
- The original offering price for a company’s securities may be more accurately determined in a primary direct listing, because it will be based on market interest and matching of buy and sell orders, instead of negotiation between the issuer and the underwriters
- Primary direct listings will facilitate orderly distribution and trading of shares, and foster competition
Potentially foreshadowing future SEC guidance under a new Administration, Commissioners Lee and Crenshaw expressed support for considering what might trigger status as a statutory underwriter for financial advisors or other market participants in a primary direct listing. They also supported consideration of additional actions to protect investors, such as requiring directors to retain a financial advisor to provide independent advice, or precluding use of the process by any issuers that do not provide ongoing auditor attestations or reports about management’s assessment of its internal controls.