August 2, 2006

Nasdaq Emerges as an “Exchange”

On Monday, the SEC issued this press release announcing that companies listed on the Nasdaq Stock Market will transition to registration under Section 12(b) of the Securities Exchange Act of 1934 effective as of Monday. The Nasdaq Stock Market commenced operation as a national securities exchange yesterday.

As I have indicated would happen in prior blogs, under an order issued by the SEC, all Nasdaq companies became Section 12(b) registrants instead of 12(g). Among other consequences, this means that these companies will need to indicate such on the front of their Form 10-Ks (listing common stock under the 12(b) line, instead of 12(g)) – and that companies de-registering will need to file a Form 25 with Nasdaq in addition to a Form 15 with the SEC, and that deregistration will not be based solely on the number of stockholders (see our Q&A Forum for a recent question regarding a company de-registering right now, which poses really tricky transition issues). Other consequences of this transition were covered in recent issues of The Corporate Counsel.

In addition, the SEC issued an exemptive order allowing Nasdaq members, brokers and dealers to execute trades until August 1, 2009, in 13 Nasdaq-listed firms that were previously exempted from SEC registrations. Nasdaq sought the relief saying an immediate registration requirement could prompt the firms – four insurance companies and nine non-U.S. firms – to withdraw from Nasdaq trading altogether.

Congrats to Nasdaq after wading through a prolonged regulatory process. In fact, outgoing SEC Commissioner Glassman alluded to how long it took for Nasdaq to obtain regulatory approval of its exchange application – which I believe is in the 6-7 year range – in her outgoing speech

Nasdaq as an Exchange: Blue Sky Implications?

Nasdaq’s transition to an exchange and its related name changes may give rise to some blue sky interpretive questions. As you may recall, the National Securities Markets Improvement Act of 1996 (known as “NSMIA”) preempted state qualification/registration requirements for “covered securities” which include a security that is listed on the “National Market System of the Nasdaq Stock Market (or any successor to such entities)”. The bifurcation of the National Market System into the Global National Market and the Global Select Market as proposed by the Nasdaq proposed rule change creates some ambiguity as to whether both markets will be considered as successors.

A further wrinkle is added by the continuing value of state level exemptions for options or warrants to acquire listed securities. The NSMIA did not clearly preempt state qualification requirements for options or warrants to acquire covered securities, as discussed in May-June 2003 issue of The Corporate Counsel. This “gap” is filled by exemptions that continue under some state blue sky laws.

For example, California Corporations Code Section 25100(o) exempts a security listed or approved for listing on the National Market System (or any successor) as well as any warrant or right to purchase or subscribe to the security. California also requires that offers or sales of any security in a nonissuer transaction must be qualified or exempt from qualification. Corporations Code Section 25101(a) exempts from this qualification requirement any security (i.e, not just a covered security) that is issued by a person that is the issuer of any security listed on a national securities exchange or the National Market System (or any successor).

Finally, California has an exemption from its constitutional usury provisions for evidences of indebtedness if the issuer has any security listed or approved for listing upon notice of issuance on a national securities exchange or on the National Market System (or any successor). In each of these cases, the National Market System must be certified by rule or order of the California Commissioner of Corporations. See, e.g., Release 87-C (revised) and Release 88-C. All this is to explain that the move to exchange status and the name changes should give rise to some interpretive questions under state law. Thanks to Keith Bishop for his input here.

Last Word: Cumulative Voting and Majority Voting

Yesterday’s blog contained a rebuttal from CalPERS on the topic of cumulative voting and majority voting. Here is a counterpoint from Keith Bishop: “There is a very sound reason for not allowing majority voting when a corporation has cumulative voting available to stockholders. At its core, majority voting establishes a significantly less burdensome way to remove directors without cause. California Corporations Code Section 303 protects directors from removal when those directors were elected by cumulative voting. This is true even when a majority of the outstanding shares has voted for removal. There is a very sound reason for this.

If removal could be effected by a majority of the shareholders, then the right to elect directors cumulatively would be largely meaningless. While SB 1207 does not amend Section 303, it creates a total end-run on the minority protections of Section 303 and cumulative voting rights in general. Delaware and Nevada provide similar (but not exactly the same) protections to for cumulative voting in DGCL Section 141(k)(2) and NRS 78.335 (Note that Nevada requires a 2/3 vote for removal).

The implications of SB 1207 are illustrated by the following example. A corporation has 7 directors and 1000 outstanding shares. If a meeting is held to elect all 7 directors and all 1000 shares are voted, a minority group holding 126 shares could elect a director under cumulative voting. Without Section 303(a)(1), the holders of 501 (a majority of the outstanding shares) could take action to remove this director without cause. Obviously, electing a director only to have her removed would be pointless. Under Section 303(a)(1), however, cumulative voting is protected.

For example, assume that the majority shareholders seek removal at a meeting. If 800 shares are present and voting at the removal meeting, the holders of 101 shares could block removal of the director. Note that Section 303(a)(1) implicitly assumes that abstentions and other shares that are note voted should not be counted as supporting removal. If SB 1207 is enacted, removal in the above example could be effected by as few as 251 shares! This is far less than the 501 votes that would be required for removal even without the special cumulative voting rule in Section 303(a)(1). SB 1207 can thus have the effect of turning majority rule into minority rule – especially if the minority is held by a few shareholders and the majority is widely dispersed.

I believe that my views regarding the incompatibility of cumulative voting and majority voting are very much in the mainstream. The ABA’s amendments to the Model Business Corporation Act do not allow majority voting if a corporation has cumulative voting.”