TO GO PRIVATE OR TO GO DARK, THAT IS THE QUESTION

TO GO PRIVATE OR TO GO DARK,

THAT IS THE QUESTION

Risk to Consider Before Delisting

By Sunny J. Barkats

There are more than 15,000 publicly traded companies, many of which receive little benefit in being public. In recent times, the motivation for going public, even for venture capitalist backed entities, is often simply to provide liquidity and has little to do with maximizing value for the remaining shareholders.

In light of increasingly turbulent conditions facing publicly traded companies today, going private may be a rational option, even for companies that recently became public. In fact, the simple elimination of the growing regulatory costs imposed on public companies may be reason enough.

Small and mid-size issuers have been particularly vulnerable to the recession. The cost of being a listed company rose dramatically over the past few years, the passage of Sarbanes-Oxley meant greater liability risk for officers and directors, and compliance got more complex as SEC scrutiny grew stringent. To top it all, the market for Private Investment in Public Equity is stagnant, and no one expects a near-term return to reasonable deal terms providing small-cap issuers with sufficient capital.

For public companies, a “going private” or “going dark” transaction may allow them to focus on long-term strategy rather than quarterly results and save substantial capital needed to grow their business. With the market undervaluing many companies’ shares due to systemic price dislocations, going private can provide liquidity for investors and allow company management to shift its focus and resources away from compliance and reporting activities and toward running the business and building long-term value.

Going Dark
Going dark and going private are sometimes confused with one another. Going dark is simpler; there is no actual transaction to complete, and the process is generally more time efficient and less costly than going private.

Going dark requires the filing of a simple form with the SEC to delist the company’s shares from an exchange and can be affected when a company has fewer than 300 shareholders on record or less than 500 record shareholders and less than $10 million in assets at the end of its last three fiscal years (excluding beneficial shareholders in street names).

For companies listed on a national securities exchange such as NYSE, NYSE Alternext, or NASDAQ, going dark requires filing forms 15 and 25 to suspend its public status and reporting obligations. The company doesn’t have to file a disclosure document with the SEC to go dark and doesn’t have to describe the transaction to its shareholders.

Though the required forms and process are simple and inexpensive, a company must properly analyze all aspects of going dark to determine if doing so is appropriate and to ensure compliance with all SEC regulations. Furthermore, it is imperative to keep in mind that the company may be required to “turn the light back on.”

This can happen for reasons outside of a company’s control, like when a broker dealer that holds company stock in street name distributes that stock to the beneficial owners, thereby effectively increasing the number of record owners. Though delisting under form 25 will terminate registration under Section 12(b) of the Exchange Act, the company’s SEC reporting obligations are not terminated because the shares still will be registered under Section 12(g).

To deregister under Section 12(g) and suspend reporting obligations, the issuer must still file form 15, certifying that it meets the 300/500 stockholder requirement. Deregistration under Section 12(g) is effective 90 days after filing form 15. If the SEC denies termination of registration under Section 12(g), the company will have 60 days to file all periodic reports that it would have been required to file had form 15 not been filed.

More important, companies going dark usually continue to trade after the date of deregistration in an OTC “Pink Sheets” market. Shareholders wishing to obtain information on a company after it has gone dark may request the books and records of the company by following applicable state law procedures.

Going Private
In contrast to going dark, a going private transaction requires an active “purchase” transaction to bring the shareholders of record below the 300/500 shareholders level as defined in Rule 13e-3 of the Securities Exchange Act of 1934.

A going private transaction often involves a cash transaction to purchase the shareholders’ shares in the company in order to reduce the shareholders base and enable the company to terminate its public status.

Going private can be accomplished either through a merger with a newly created entity owned by a control group; a tender offer by the newly formed entity; or a self tender offer by the company on its own shares with a reverse split. Going private requires complex filings with the SEC under Rule 13e-3, or, if accomplished by an issuer self-tender, Rule 13e-4. If the transaction is an issuer tender offer, the company will be required to file a Schedule 13E-3 or Schedule TO.

If the transaction involves a tender offer, or if the consideration is going to consist in whole or in part of securities of another issuer, disclosure under Regulation 14D, Regulation 14A, or Regulation 14C also will be required. Preparing the SEC filings and the necessity of SEC review means that a going-private transaction will generally take months to complete. This process is more costly and time-consuming than going dark. However, when it is completed, the company’s shares are no longer publicly traded.

Regardless of whether a going dark or going private transaction is selected, the issuer is relieved of periodic reporting requirements, compliance with Sarbanes-Oxley, and compliance with the rules and regulations of the stock exchange on which its shares were listed. Each approach has its advantages and disadvantages.

Litigation Risks
Though there is no affirmative duty to ensure a market in a company’s stock, a shareholder may argue that going dark is a breach of fiduciary duty because those shareholders assumed or expected the company’s stock would have greater liquidity and that the company encouraged this assumption or expectation.

It is recommended that an issuer choosing to go dark consider issuing a press release, providing its stockholders with the opportunity to sell the company’s shares through an exchange prior to their delisting. While shareholder approval is not required in a going dark transaction, deregistering will likely cause some shareholders to sell and lead to a marked decline in share price. This decline in share price increases the potential for litigation as disgruntled shareholders file claims relating to the deregistration.

Technically, the board of directors of the company going dark must authorize the going dark procedures and filing of form 15. Board approval must be given at a duly-called meeting or by unanimous written consent. In approving the decision to go dark, a board of directors must fulfill its fiduciary duties. Hence, the board of directors must believe in good faith that going dark is in the best interest of the company and its shareholders.

The board’s decision is usually reviewed under the business judgment rule standard. A few cases indicate that a company’s directors may breach their duties in pursuing such a plan if they do so for self-interested purposes.

In Hamilton v. Nozko, the court reasoned that corporate action, even where legally permissible, might be forbidden if it’s taken for an unsuitable purpose. In the Hamilton case, the court noted that directors exercising business judgment could incidentally take steps that cause delisting and deregistration that might negatively impact the market for the company’s securities.

The principal risk implication for going private transactions arises from the fact that there is an active plaintiff’s bar that opposes most going private transactions, making litigation more likely to occur. When and if litigation ensues, the board will have to meet this higher standard in defending both its decision to go private and the method by which it did.

Going private transactions, however, are usually favored by shareholders and institutional investors because they require shareholder approval in certain circumstances (e.g., mergers and reverse splits) or affirmative actions by the shareholder to tender their shares (which they have the option to do or not do depending on the perceived fairness of the transaction). Though in some instances a going private transaction can save the company considerable time, money, and energy, it’s likely to be an unpopular process with shareholders.

The most pressing legal issue confronting any proponent of a going private transaction is whether the proposed transaction will survive scrutiny under state law standards that govern going private transactions. For this reason, the directors should be concerned that their decision fully conforms to the constraints imposed upon them as fiduciaries under state law. Under Delaware law, management’s decision to go private is evaluated under the business judgment rule, which sets up a strong presumption of the validity of board action.

Pursuant to the business judgment rule, a company’s board of directors is clothed with the presumption of being motivated by a bona fide regard for the interests of the company. The presumption is that in making a business decision like whether to go private, the company’s directors are not acting out of self-interest or engaging in self-dealing, but rather acting on an informed basis, in good faith, and in an honest belief that going private is in the company’s best interest.

Go Dark or Private Cautiously
Readers should keep in mind that dissenting shareholders may sue a company for going private or going dark, and the cause of action upon which they can base their claims are diverse. Minority shareholders have, in many cases, filed a derivative action against a company’s decision to go private. Shareholders often allege the intent to deceive, manipulate, or defraud shareholders.

But the burden of proof is on the plaintiff, and the standard is by a preponderance of the evidence. Therefore, it has been difficult for minority shareholders to obtain a judgment in their favor. It’s not easy to prove a malicious intent to defraud shareholders, or to prove a coercive intent behind the company’s decision to go dark or private, especially since there lies in today’s market relatively obvious circumstantial economical reasons to conclude that it’s in the best interest of many small-to-mid-cap issuers to become private. But a costly and time-consuming dispute may arise regardless.

I recommend that the decision to go dark or private be carefully considered; it’s more complex than it seems, and it’s important to retain proper legal and accounting professionals early on in the process. Primary among concerns should be a weighing of the benefits of remaining public against the benefits from going dark or going private. Important factors such as share price, company performance, public float, and the SEC costs of compliance should be weighed against the company’s needs to have publicly traded stock as acquisition currency.

Sunny J. Barkats is a pioneer in the PIPE and APO markets and the partner responsible for building the securities/capital markets law practice group at internationally-known law firm JSBarkats Pllc. in New York. www.JSBarkats.com sbarkats@jsbarkats.com

E-Proxy Amendments

E-Proxy Amendments

The SEC Approved Amendments Regarding the Notice of Internet Availability of Proxy Materials on February 22, 2010

As of January 1, 2009, the SEC requires companies to post proxy materials on an internet site and provide Notice of Internet Availability of Proxy Materials (the “Notice”) to shareholders. As you may know companies have two options for delivering proxy materials to shareholders:

1. Full set delivery option: companies may deliver the traditional full set of paper copies and the Notice along with the posting of the proxy on the internet; or

2. Notice-only option: companies may deliver the Notice to shareholders instructing them how to access the proxy materials on the Internet.

On February 22, 2010 the SEC approved amendments to the E-Proxy rules concerning its notice and access rules to provide flexibility regarding the format of the Notice that is delivered to shareholders. The amendments afford companies seeking to take advantage of the E-Proxy rules the opportunity to better educate their shareholders about the process of receiving and reviewing proxy materials and voting under the E-Proxy rules. The amendments shall go effective on March 29, 2010, and public companies with annual meetings scheduled for mid-May or later should consider taking advantage of these rule changes.

The E-Proxy rules describe the exact form and content of the Notice, which includes a legend of over 100 words in bold-face. Some concerns were raised that the Notice was a boilerplate and that companies were limited in their ability to effectively communicate with shareholders about the E-Proxy process. However, the amendments require that the E-Proxy rules provide companies with additional flexibility in formatting and selecting the language to be used in the Notice. The amended E-Proxy rules require a much shorter legend for the Notice, limiting it to the following:

"Important Notice Regarding the Internet Availability of Proxy Materials for the Shareholder Meeting to be Held on [insert meeting date]."

The SEC still requires that certain specific points be addressed in the Notice, but companies now have more flexibility in conveying the following information to shareholders in the Notice:

a. A specification that the Notice is not a form for voting and presents only an overview of the more complete proxy materials, which contain important information and are available on the Internet or by mail

b. An advisement that shareholders access and review the proxy materials before voting

c. The internet web site where the proxy materials are accessible

d. Instructions regarding the process for reluctant shareholders to request a paper or email copy of the proxy materials at no additional charge, including the date by which they should make the request as well as an indication that they will not otherwise receive a paper or email copy.

The new amendments to the E-Proxy rules also allow companies to include additional explanatory materials with the Notice.

Notice Timelines for Other Soliciting Persons

As of now, under the proxy rules, the ultimate deadline is the later of (i) 40 calendar days before the shareholder meeting or (ii) 10 calendar days after the issuer company first sends its Notice or proxy statement to shareholders. However, this had the practical effect of limiting the use of the E-Proxy rules (the notice-only option) because comments on preliminary proxy statements filed by such persons could take longer than 10 days to resolve. Hence, non-issuer soliciting persons must file a preliminary proxy statement within 10 calendar days after the issuer files its definitive proxy statement and must send its Notice to shareholders no later than the date on which the definitive proxy statement is filed with the SEC.

JSBarkats' Opinion

We believe that this new E-Proxy amendment provides companies more efficient and effective use of the notice-only option of proxy material delivery. Moreover, we suggest that any investors that wish to know about the proxy matters read the newly issued SEC publication, “Spotlight on Proxy Matters”. Furthermore, the changes to NYSE Rule 452 and the abolition for brokers to vote uninstructed shares in director elections should make companies consider the impact of the loss of discretionary broker votes in director elections.

If you have any other questions or concerns regarding the E-Proxy rules and any amendments thereto, please feel free to contact Sunny J. Barkats at sbarkats@jsbarkats.com.

Author: Sunny J Barkats, Partner Co-Author: Lawrence Metelitsa, Associate www.jsbarkats.com

WHO IS AN "AFFILIATE"?

Memorandum  

Date:  2/16/2011
By:  Sunny J. Barkats, Managing Partner
Re:   WHO IS AN "AFFILIATE"?

         

Definition of “Affiliate”

Rule 405 of the Securities Act of 1933, as amended, defines an “affiliate of an issuer” as “a person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common controls with, such issuer.” However, directors, executive officers and beneficial owners of a substantial percentage of an issuer’s outstanding equity securities are generally deemed to be affiliates of an issuer; also Section (a)(1) of Rule 13e-3 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), also defines “affiliate” of an issuer in relevant part as”…a person that directly or indirectly through one or more intermediaries controls, is controlled by, or is under common control with such issuer.” The determination of whether a person controls an issuer is based on totality of the facts and circumstances; under Rule 12b-2 of the Exchange Act, which provides definitions applicable to Rule 13 of the Exchange Act, “the term ‘control’ (including the terms ‘controlling,’ controlled by’ and ‘under common control with’) means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities by contract, or otherwise.”

What Percentage of Ownership of Outstanding Stock Constitutes “Control”?

There is no hard and fast rule governing when control will and will not be found to exist based on percentage voting-stock ownership for purposes of Rule 12b-2. To the contrary, the Securities and Exchange Commission (the “SEC”) refuses to make abstract determinations regarding the presence or absence of control, and will not issue No-Action letters on the subject.[1] The test of control is based on the facts and circumstances of the transaction and the parties thereto. There is a significant body of case law finding that ownership of a certain percentage of stock is not determinative of control. Most of these cases involve a finding of control where a minimal amount of equity was owned.[2] However, those cases suggest that ownership of a seemingly significant amount of stock does not automatically signal control.[3]

           

The term “control[4]” (including the term “controlling” “controlled by” and “under common control with”) means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through ownership of voting  securities, by contract, or otherwise. The rule of thumb is that an individual or entity that holds roughly 10% or more of an issuer’s outstanding equity securities has the ability to exercise some degree of control. The reasoning behind seems to be that when a shareholder owns sufficient stock in a corporation that management is likely to be responsive to or influenced by the shareholder’s requests or demands, thus, the SEC says the shareholder is an affiliate of the corporation.

Conclusion

            Under the safe harbor adopted by the SEC, a person who is not an executive officer or a shareholder owning 10% or more of any class of voting equity securities of a specified person will be deemed not to control such specified person. An “executive officer” is defined in Exchange Act Rule 3b-7. The 10% ownership test is to be determined consistent with the Exchange Act, Rule 13d-3. A person who cannot rely on the 10% ownership prong of the safe harbor will not be deemed to be, or presumed to be, an affiliate. Rather a facts and circumstances analysis of control will be necessary. Only executive officers, directors that are also employees of an affiliate, general partners and managing members if an affiliate will be deemed to affiliates.

---

[1] Procedures Utilized by the Division of Corporate Finance for Rendering Informal Advice, Interpretive Release No. 33-6253, 45 FR 72644 (Nov. 3, 1980); see, e.g. Textron, Inc., SEC No-Action Letter, LEXIS 4050 (Dec. 1980).

[2] For a full discussion and thorough list of cases see LOUIS J. LOSS & JOEL SELIGMAN, SECURITIES REGULATION VOLUME IV 1707-1712.

[3] See, e.g., Kennecott Copper Corp. v. Curtiss-Wright Corp., 449 F. Supp. 951 (S.D.N.Y.), aff’d in part and rev’d in part, 584 F. 2d 1195 (2d Cir. 1978); Graphic Sciences, Inc. v. International Mogul Mines, Ltd., 397 F. Supp. 112, 125 (D.C.D.C. 1974)

[4] Technically, the definitions contained in Rule 405 relate to terms used in Securities Act Rules 400 through 494 or terms used in Securities Act registration form. The Definitions of “control” is a reliable definition for general Securities Act purposes.

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FINRA Amendment to Proposed Rule 5131

MEMORANDUM

Re: FINRA Amendment to Proposed Rule 5131

Date: 4/26/2010

By: Lawrence Metelitsa

On September 15, 2003, NASD now the Financial Industry Regulatory Authority ("FINRA") filed a proposed rule change to adopt new FINRA Rule 5131 (originally proposed as NASD Rule 2712) to deal with disclosure and management of conflicts of interests that may adversely affect the allocation and distribution of IPOs. The proposed rule change was meant to create greater public confidence in the IPO process, which is vital to the continued growth and success of the capital markets. The NASD amended the proposed rule change on December 9, 2003 and August 4, 2004. The most recent amendment was proposed by FINRA on February 17, 2010. This latest Amendment seeks to regulate member firms by implementing the following rules:

Quid Pro Quo Allocations: The Amendment to this rule means that members, or those persons associated with members, may not withhold or threaten to withhold, any allocated shares from an I.P.O in order to collect excessive fees relative to the services provided by the member. 

Spinning: In investment banking the act of "Spinning" refers to the allocating of shares of a hot initial offering by a securities firm to the personal account of a corporate executive in anticipation of gaining future business from the executive's firm. The Amendment to 5131 prevents members, or persons associated with members, from Spinning in the following circumstances: :

(i) if the company is currently an investment banking services client of

the member or the member has received compensation from the company for

investment banking services in the past 12 months;

(ii) if the member intends to provide, or expects to be retained by the

company for, investment banking services within the next 3 months; or

(iii) on the express or implied condition that such executive officer or

director, on behalf of the company, will retain the member for the performance of

future investment banking services.

Policies Concerning Flipping: The practice of flipping refers to that no member, or person associated with a member, may directly or indirectly recover, or attempt to recover, any portion of a commission or credit paid or awarded to an associated person for selling shares in an IPO that are subsequently flipped by a customer, unless the managing underwriter has assessed a penalty bid on the entire syndicate. Furthermore, any obligation to maintain records relating to penalty bids falls under SEA Rule 17a-2(c)(1), a member shall promptly record and maintain information regarding any penalties or disincentives assessed on its associated persons in connection with a penalty bid.

IPO Pricing and Trading Practices.  In an equity I.P.O. The book-running lead manager must provide to the issuer’s pricing committee (or, its board of directors if no pricing committee exists) a "Regular Report of Indications of Interest", which is to include the names of interested institutional investors and the number of shares indicated by each, as reflected in the book-running lead manager’s book of potential institutional orders, and a report of aggregate demand from retail investors. In addition, after the settlement date of the IPO, a report of the final allocation of shares to institutional investors, as reflected in the books and records of the book-running lead manager, including the names of purchasers and the number of shares purchased by each, and aggregate sales to retail investors must also be provided to the issuer’s pricing committee (or, its board of directors if no pricing committee exists).


Lock-Up Agreements.  A "Lock- Up" Agreement is a legally binding contract between the underwriters and insiders of a company prohibiting these individuals from selling any shares of stock for a specified period of time. The latest amendment to Rule 5131 promulgates that (i)any lock-up agreement or other restriction on the transfer of the issuer’s shares by officers and directors of the issuer shall provide that such restrictions will apply to their issuer-directed shares; and (ii) at least two business days before the release or waiver of any lock-up or other restriction on the transfer of the issuer's shares, the book-running lead manager will notify the issuer of the impending release or waiver and announce the impending release or waiver through a major news service, except where the release or waiver is effected solely to permit a transfer of securities that is not for consideration, and where the transferee has agreed in writing to be bound by the same lock-up agreement terms in place for the transferor.

Agreement Among Underwriters.  The agreement between the book-running lead manager and other syndicate members must require, to the extent not inconsistent with SEC Regulation M, that any shares trading at a premium to the public offering price that are returned by a purchaser to a syndicate member after secondary market trading commences be used to offset the existing syndicate short position or, if no syndicate short position exists, the member must offer returned shares at the public offering price to unfilled customers’ orders pursuant to a random allocation methodology.

Market Orders.  No member may accept a market order for the purchase of IPO shares prior to the commencement of trading on the secondary market.

The comment period for this, third amendment, to proposed rule 5131 ended on April 8, 2010. The text of the original rule and all subsequent Amendments can be found at FINRA.org. 

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