On February 2, 2018, the Securities and Exchange Commission approved a change to the New York Stock Exchange’s (Exchange) listing rules that permit companies to use “direct listings” to list their shares on the Exchange based on having a minimum independent valuation of $250 million and without having completed an underwritten initial public offering (IPO) or having their shares first traded on a private market. Direct listing will continue to be at the NYSE’s discretion and require that the company have an effective resale registration statement on file with the SEC for at least some amount of its outstanding shares. Direct listings provide an option by which private companies can accomplish three goals without requiring an IPO: (a) make their shares a more attractive currency for merger and acquisition activity, (b) provide greater liquidity for existing shareholders, and (c) increase the value of their shares and employee stock options. The SEC approval comes in the wake of recent commentary by SEC Chairman Jay Clayton that he believes more IPOs are needed, noting they are generally beneficial to the retail investor community to the extent they provide investors with more investment alternatives, more opportunities to invest, and greater liquidity.
The revised NYSE listing rules went into effective on February 2, 2018. The revised rules are Section 102.01B of the NYSE Listed Company Manual, which can be found here, and NYSE Rules 15, 104 and 123D, which can be found here. The SEC’s Adopting Release can be found here. The NYSE proposal, as amended, can be found here.
Companies have traditionally listed on the Exchange in connection with a firm-commitment underwritten IPO, a transfer from another market, or a spin-off. However, since 2008, under Section 102.01B of the NYSE Listed Company Manual, the Exchange has had the discretion, on a case-by-case basis, to allow companies that have not previously had their common equity securities registered under the Exchange Act, but which have sold common equity securities in a private placement and traded in a private market to list their common equity securities on the Exchange at the time of effectiveness of a registration statement filed solely for the purpose of allowing existing shareholders to sell their shares. The NYSE requires companies that list on the Exchange in absence of an IPO (i) to have publicly-held shares valued at $100 million and (ii) meet specified valuation requirements. The NYSE determines whether a company has met the $100 million aggregate market value of publicly-held shares requirement based on a combination of: (i) an independent third-party valuation of the company and (ii) 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. The Exchange attributes a market value of publicly held shares to the company equal to the lesser of: (i) the value calculable based on an independent third-party valuation and (ii) the value calculable based on the most recent trading price in a private placement market.
Determining Valuation. Under the revised rules, the NYSE will determine whether a company has met the $100 million aggregate market value of publicly-held shares requirement based on: (i) an independent third-party valuation of the company or (ii) the most recent trading price for the company’s common stock in a private placement market. The NYSE expressed the view that the independent valuation option accommodates private companies “that are clearly large enough to be suitable for listing” but (i) do not have shares traded on a private placement market or (ii) experience such limited trading of their shares in the private placement market such that trading cannot provide a reasonable basis for determining a valuation. According to the NYSE, the rule change is necessary to compete for listings that might otherwise be on the Nasdaq Stock Market (Nasdaq) as Nasdaq listing rules do not explicitly limit a private company’s ability to list without a public offering or prior public market price.
Increased Minimum Valuation. Pursuant to the revised rules, companies that engage in a direct listing using the valuation option must provide a recent valuation evidencing their publicly held shares have a market value of at least $250 million. The NYSE stated that increasing the minimum valuation by two-and-a half times over the current $100 million requirement is designed to provide “a significant degree of comfort that the market value of a company’s shares will meet the [$100 million] standard upon the commencement of trading.”
Independence of Third-Party Valuation Agents. The revised rules establish new independence criteria for valuation agents. An agent will not be deemed independent if: (i) at the time it provides the valuation, the valuation agent or any affiliated person beneficially owns more than five percent of the class of securities to be listed, including any right to receive any such securities exercisable within 60 days; (ii) the valuation agent or any affiliated entity has provided any investment banking services to the listing applicant within the 12 months preceding the date of the valuation; or (iii) the valuation agent or any affiliated entity has been engaged to provide investment banking services to the listing applicant in connection with the proposed listing or any related financings or other related transactions. Consistent with the prior version of the rule, the valuation must be provided by an entity that has significant experience and demonstrable competence in the provision of such valuations.
Resale Registration Statement. The revised rules did not change the requirement that a company pursuing a direct listing must file and have declared effective a resale registration statement for at least some amount of its outstanding shares. The registration statement, usually on Form S-1 for U.S. issuers or Form F-1 for foreign issuers, will be subject to the traditional review and comment process of the SEC staff. As a practical consideration, if the resale registration is reviewed by the SEC, effectiveness would typically take 40 days or more; and if the resale registration is not selected for review, effectiveness could be achieved as quickly as 5-12 business days after initial filing.
Designated Market Maker. The revised rules also address how a designated market maker (DMM) should establish the reference price for the opening on the first day of trading of the shares for a company that is direct listing. If the shares have a sustained trading history on a private placement market, then the price will be the most recent transaction in such market. If not, the DMM must consult with a financial adviser to the issuer to determine the reference price. The NYSE stated that it believes that such a financial advisor would have an understanding of the status of ownership of outstanding shares in the company and would have been working with the issuer to identify a market for the securities upon listing. As a result, the NYSE believes such financial advisor would be able to provide input to the DMM regarding expectations of where the new listing should be priced, based on pre-listing selling and buying interest and other factors that may not be available to the DMM through other sources.
Regulatory Halt. The NYSE may declare a regulatory halt in certain securities that are the subject of an initial pricing on the Exchange and have not been listed on an exchange or quoted in an over-the-counter quotation medium immediately prior thereto. The regulatory halt allows the NYSE to preclude other markets from trading a security until the Exchange has completed its initial pricing process. The SEC has stated the proposed change will facilitate the initial opening by the DMM of shares in a direct listing, and thereby promote fair and orderly markets and the protection of investors.
Listing Requirements Continue to Apply. Companies listing upon an effective registration statement are still required to satisfy the distribution requirements set forth in Section 102.01A (i.e., that the company have 400 beneficial holders of round lots of 100 shares and 1,100,000 publicly-held shares), the requirements of Section 102.01B (which includes a $4.00 price requirement at the time of initial listing), and one of the financial standards set forth in Section 102.01C of the Manual (i.e., the Earnings Test or the Global Market Capitalization Test), as well as comply with all other applicable NYSE rules, including the corporate governance requirements.
It remains to be seen, however, how the revised rules will play out in practice. Some of the relevant open questions include:
- What impact will the expanded availability of direct listings have on IPO activity? One could argue that the greatest attraction of direct listing is that it can nearly match private markets in being faster and less costly than an IPO, while also minimizing litigation risk. In some cases, it could provide nearly the same liquidity as a traditional IPO, although, as discussed below, trading price certainty and trading volume could be lower following a direct listing than following an IPO. Direct listings have been available on the NYSE and Nasdaq for a decade but have not been utilized regularly by large private companies in lieu of a traditional IPO. In any event, the requirement for 400 round lot holders will continue to be a hurdle for many private companies looking to list directly.
- How will legal, diligence and auditing practices develop around direct listings, which do not involve the traditional diligence undertaken by a firm commitment underwriter? Because the listing must be accompanied by an effective registration statement under the Securities Act, the liability provisions of Section 11 and 12 of the Securities Act will be applicable to sales made under the registration statement. It might be that selling shareholders (who may be deemed underwriters) require the protective procedures. Of course, follow-on offerings by the issuer that involve firm commitment underwriting or at-the-market programs will require the traditional diligence practices and the first such event after listing may result in more thorough diligence than would be required for an issuer who initially listed via an IPO. Separately, it remains to be seen whether the independent financial adviser could be subject to Securities Act liability, or at least lawsuits alleging underwriter liability, in connection with determining the opening trading price.
- Will the initial trading price be subject to downward pressure because of the “overhang” created by the resale shelf registration statement? Shareholders whose shares are registered on the resale registration statement will be able to sell onto the Exchange immediately upon listing. Any overhang, which will depend on public statements by the issuer and shareholders, could put downward pressure on the stock price and incentivize short-selling activity in the shares. This risk of short-selling is one driver of the revised rules’ allowing the Exchange to halt trading in the shares in other markets prior to initial trading on the Exchange.
- Because the expanded rules do not require that the issuer’s shares be traded on a private market or another exchange prior to the direct listing, how will the initial trading price be determined? There is no reference price from another market for the DMM to apply and no negotiation between the issuer and the underwriter as in an IPO. The NYSE seems to bridge this gap with the requirement for the DMM to consult with an independent financial adviser to determine the initial trading price. Eventually, a standardized set of practices around the financial adviser’s work and presentation of the price to the issuer and the Exchange should develop.
- Without the firm commitment IPO process, in which the offering is oversold and heavily marketed, how will direct listed shares trade in the after-market? Without an underwritten offering, the issuer will not engage in price finding and book building activities. Sell-side analysts will presumably not be involved, building models and educating investors. It may be more difficult for the issuer to tell its forward-looking story and build value into the trading price of the stock without research coverage prior to listing. However, some of the cash rich companies that have taken advantage of direct listings may not put much value in a price increase after listing because they have already raised large amounts of capital through private placements.
- Will large private placements (often called “private IPOs”) have a new advantage? The expanded option to direct list through an independent valuation alone may make capital raising through large private placements more efficient as investors see an additional path to greater liquidity for their privately placed shares.
 As discussed in SEC Release No. 34-81440, Nasdaq has listed a number of previously private companies in conjunction with the effectiveness of a resale registration statement without an underwritten offering. In addition, Nasdaq’s initial listing rules do not explicitly address how Nasdaq determines compliance with its initial listing market capitalization requirements by private companies seeking to list upon effectiveness of a resale registration statement or Exchange Act registration statement without a concurrent IPO. In light of this precedent and the absence of any Nasdaq provision limiting the ability of a company to qualify for listing without an IPO or prior public market price, it is believed that Nasdaq would take the position that it could also list a previously private company upon effectiveness of registration statement without a concurrent public offering.
 “Investment banking services” includes acting as an underwriter in an offering for the issuer; acting as a financial adviser in a merger or acquisition; providing venture capital, equity lines of credit, PIPEs (private investment, public equity transactions), or similar investments; serving as placement agent for the issuer; or acting as a member of a selling group in a securities underwriting.
Many thanks to Lindsay Ellis in our Houston office for her work summarizing the NYSE amendments above.