The NYSE’s Complex Shareholder Approval Rules: Issuing New Securities? Do You Need Shareholder Approval?

By: Stuart H. Gelfond and Burcin Eren.

THE NEW YORK STOCK EXCHANGE (NYSE) HAS SPECIFIC requirements applicable to listed companies to receive shareholder approval in connection with certain transactions, including issuing equity and convertible securities, which are in addition to any applicable requirements under state law and SEC rules. Although these rules can be seen as complex and technical, it is very important to understand them, especially considering the extra time and expense that may come with the shareholder approval process. Under Section 312.03 of the NYSE Listed Company Manual, shareholder approval by a majority of votes cast on a proposal is a prerequisite to issuing securities in connection with any of the following situations.

Equity Compensation Plans and Arrangements

Pursuant to Section 303A.08, with limited exemptions explained below, shareholders must be given the opportunity to vote on all equity-based compensation plans, which are defined as plans or other arrangements that provide for the delivery of equity securities (either newly issued or treasury shares) of the listed company to any employee, director, or other service provider as compensation for services. Moreover, a compensatory grant of options or other equity securities that is not made under a plan is considered an equity compensation plan under the NYSE rule and triggers a shareholder vote.

In addition, shareholder approval is required for a material revision of an equity compensation plan, which includes but is not limited to the following:

• A material increase in the number of shares authorized under the plan, with two exceptions:
  • Increases that reflect a reorganization, stock split, merger, spin-off, or similar transaction
  • Automatic increases or automatic grants under a “formula plan,” provided that the term of the plan is not more than 10 years:
    – Examples of automatic grants pursuant to a formula are (1) annual grants to directors of restricted stock having a certain dollar value; and (2) matching contributions, whereby stock is credited to a participant’s account based upon the amount of compensation the participant elects to defer.
    – If a plan contains no limit on the number of shares available and is not a formula plan, then each grant under the plan will require separate shareholder approval regardless of whether the plan has a term of not more than 10 years.
• An expansion of the types of awards available under the plan
• A material expansion of the class of employees, directors, or other service providers eligible to participate in the plan
• A material extension of the term of the plan
• A material change to the method of determining the strike price of options under the plan
  • A change in the method of determining the fair market value from the closing price on the date of grant to the average of the high and low price on the date of grant is not a material change.
• The deletion or limitation of any provision prohibiting repricing of options:
  • Under the NYSE rules, a “repricing” means any of the following or any other action that has the same effect:
    – Lowering the strike price of an option after it is granted
    – Any other action that is treated as a repricing under generally accepted accounting principles
    – Canceling an option at a time when its strike price exceeds the fair market value of the underlying stock, in exchange for another option, restricted stock, or other equity, unless the cancellation and exchange occurs in connection with a merger, acquisition, spin-off, or other similar corporate transaction
• A plan that does not contain a provision that specifically permits repricing of options is deemed to prohibit repricing. As a result, any actual repricing of options issued under such a plan would be considered a material revision of a plan even if the plan itself is not revised.

It is important to note that an amendment will not be considered a material revision if it curtails rather than expands the scope of the plan in question.

The NYSE provides certain exemptions to the rule and does not consider the following to be equity compensation plans; therefore, no shareholder approval is needed:

• Plans that are made available to shareholders generally, such as a typical dividend reinvestment plan
• Plans that merely allow employees, directors, or other service providers to elect to buy shares on the open market or from the listed company for their current fair market value, regardless of whether:
  • The shares are delivered immediately or on a deferred basis
  • The payments for the shares are made directly or by giving up compensation that is otherwise due (for example, through payroll deductions)

In addition, as explained in more detail below, the NYSE does not require shareholder approval of employment inducement awards, certain grants, plans, and amendments in the context of mergers and acquisition transactions, and certain specific types of plans as long as they are made with the approval of the listed company’s independent compensation committee or the approval of a majority of the listed company’s independent directors and the NYSE is notified in writing.

Employment Inducement Awards

• An employment inducement award is a grant of options or other equity-based compensation as a material inducement to a person or persons being hired by the listed company or any of its subsidiaries, or being rehired following a bona fide period of interruption of employment.
• Inducement awards also include grants to new employees in connection with a merger or acquisition.
• The listed company must disclose in a press release the material terms of the award, including the recipient(s) of the award and the number of shares involved, promptly following a grant in reliance on this exemption.

Mergers and Acquisitions

• There are two exemptions related to whether approval is required for an employee compensation plan that apply in the context of mergers and acquisitions:
  
  1) Shareholder approval will not be required to convert, replace, or adjust outstanding options or other equitycompensation awards to reflect the transaction.
  2) Shares available under certain plans acquired in corporate acquisitions and mergers may be used for certain post-transaction grants without further shareholder approval. This exemption applies to situations where a party that is not a listed company following the transaction has shares available for grant under preexisting plans that were previously approved by shareholders. Shares available under such a preexisting plan may be used for post-transaction grants of options and other awards with respect to equity of the entity that is the listed company after the transaction, either under the preexisting plan or another plan, without further shareholder approval, so long as:
  (i) The number of shares available for grants is appropriately adjusted to reflect the transaction.
  (ii) The time during which those shares are available is not extended beyond the period when they would have been available under the preexisting plan, absent the transaction.
  (iii) The options and other awards are not granted to individuals who were employed, immediately before the transaction, by the post-transaction listed company or entities that were its subsidiaries immediately before the transaction.

A plan adopted in contemplation of a merger or acquisition transaction would not be considered preexisting for purposes of this exemption.

• Any shares reserved for listing in connection with a transaction pursuant to either of these M&A exemptions would be counted by the NYSE in determining whether the transaction involved the issuance of 20% or more of the listed company’s outstanding common stock and thus required shareholder approval under the NYSE as explained below in more detail.

Qualified Plans, Parallel Excess Plans, and Section 423 Plans

Shareholder approval will also not be required for:

• Tax qualified plans under Section 401(a) of the Internal Revenue Code (the Code) such as employee stock ownership plans (ESOPs) or 401(k) plans
• Employee stock purchase plans intended to meet the requirements of Section 423 of the Code
• A parallel excess plan, which is defined as a pension plan that is designed to work with a tax-qualified plan to provide benefits that exceed the applicable Code limits on contributions, compensation, and benefits.
  • In order to be a parallel excess plan, the plan must (1) cover all or substantially all employees of an employer who are participants in the related qualified plan whose annual compensation is in excess of the limit specified in the Code, (2) have terms that are substantially the same as the qualified plan that it parallels except for the elimination of the applicable Code limits, and (3) provide that no participant receives employer equity contributions under the plan in excess of 25% of the participant’s cash compensation.

Certain Issuances of Common Stock, or Securities Convertible into or Exercisable for Common Stock

Shareholder approval is required prior to the issuance of common stock, or of securities convertible into or exercisable for common stock, if the number of shares to be issued or that may be convertible or exercisable exceeds either 1% of the number of shares of common stock or 1% of the voting power outstanding before the issuance, in any transaction or series of related transactions, to:

• A director, officer, or substantial security holder (those controlling 5% or more of the company’s shares or voting power) of the company (each defined as a related party)
• A subsidiary, affiliate, or other closely related person of a related party
• Any company or entity in which a related party has a substantial direct or indirect interest

Under a recent exemption adopted on December 31, 2015, these requirements do not apply to the sale of stock for cash by an early stage company, which is defined as a company that has not reported revenues in excess of $20 million in any two consecutive fiscal years since its incorporation, provided that the early stage company’s audit committee (or a comparable committee comprised solely of independent auditors) approves the transaction prior to completion. The early stage company exemption covers only sales for cash and is not available for stock issuances in connection with an acquisition.

If the related party involved in the transaction is classified as such solely because such person is a substantial security holder, and if the issuance relates to a sale of stock for cash at a price at least as great as each of the book and market value of the issuer’s common stock, then shareholder approval will not be required unless the number of shares of common stock to be issued, or unless the number of shares of common stock into which the securities may be convertible or exercisable, exceeds either 5% of the number of shares of common stock or 5% of the voting power outstanding before the issuance.¹

Under the NYSE rules, voting power outstanding refers to the aggregate number of votes that may be cast by holders of those securities outstanding that entitle the holders thereof to vote generally on all matters submitted to the company’s security holders for a vote.

Shareholder approval is required for the issuance of securities convertible into or exercisable for common stock if the stock that can be issued upon conversion or exercise exceeds the applicable percentages. This is the case even if such convertible or exchangeable securities are not to be listed on the NYSE. Only shares actually issued and outstanding (excluding treasury shares or shares held by a subsidiary) are to be used in making the calculations above. Shares reserved for issuance upon conversion of securities or upon exercise of options or warrants will not be regarded as outstanding for this purpose.

Issuances Covered by the “20% Rule”²

Shareholder approval is required prior to the issuance of common stock, or of securities convertible into or exercisable for common stock, in any transaction or series of related transactions if:

• The common stock has, or will have upon issuance, voting power equal to or in excess of 20% of the voting power outstanding before the issuance of such stock or of securities convertible into or exercisable for common stock.
• The number of shares of common stock to be issued is, or will be upon issuance, equal to or in excess of 20% of the number of shares of common stock outstanding before the issuance of the common stock or of securities convertible into or exercisable for common stock.

However, shareholder approval is not required for any such issuance involving:

• Any public offering for cash
• Any bona fide private financing, if such financing involves a sale of:
  • Common stock, for cash, at a price at least as great as each of the book and market value of the issuer’s common stock
  • Securities convertible into or exercisable for common stock, for cash, if the conversion or exercise price is at least as great as each of the book and market value of the issuer’s common stock

Bona fide private financing is defined as a sale in which either:

• A registered broker-dealer purchases the securities from the issuer with a view to the private sale of such securities to one or more purchasers.
• The issuer sells the securities to multiple purchasers, and no one such purchaser, or group of related purchasers, acquires, or has the right to acquire upon exercise or conversion of the securities, more than 5% of the shares of the issuer’s common stock or more than 5% of the issuer’s voting power before the sale.

Shareholder approval is required for the issuance of securities convertible into or exercisable for common stock if the stock that can be issued upon conversion or exercise exceeds the applicable percentages. This is the case even if such convertible or exchangeable securities are not to be listed on the NYSE. Only shares actually issued and outstanding (excluding treasury shares or shares held by a subsidiary) are to be used in making the calculation above. Shares reserved for issuance upon conversion of securities or upon exercise of options or warrants will not be regarded as outstanding for this purpose.

Change-of-Control Transactions

Shareholder approval is required prior to an issuance that could result in a change of control of the issuer. The NYSE does not define change of control and the NYSE staff has not historically provided any clear written guidance as to its scope. Nevertheless, the NYSE’s 2005 decision in the transaction that involved Banco Santander of Spain, Sovereign Bank and Independence Community Savings (the Sovereign case) indicated that the NYSE considers all facts and circumstances to determine whether a change of control has occurred instead of following a strict numerical test. Indeed, the NYSE implied in the Sovereign case that even smaller transactions that involve less than 20% of the issuer’s outstanding shares may be deemed to be a change of control transaction, and thus trigger a shareholder vote, if certain specific veto and other rights are also given, such as the right to appoint directors or to terminate or veto the appointment of the CEO.

Financial Viability Exception

NYSE also provides an additional exception from the shareholder approval requirements in situations where the delay in securing stockholder approval would seriously jeopardize the financial viability of the company. This exception is generally used under extreme circumstances, such as when there is a real risk of bankruptcy, and requires an approval from the NYSE in advance. In addition, in order to take advantage of this exception, the company’s audit committee must expressly approve the reliance on this exception by the company, and the company must mail to all shareholders, not later than 10 days before issuance of the securities, a letter alerting them to its omission to seek the shareholder approval that would otherwise be required by the NYSE and indicating that the audit committee has expressly approved the exception.

So, What If You Are Not Sure Whether You Should Seek Shareholder Vote Before Issuing Securities?

Companies listed on the NYSE need to consider these rules carefully before issuing securities in order to understand whether their contemplated transaction would trigger a shareholder vote. The NYSE does not issue interpretations or guidance on its rules; however, the NYSE is willing to engage in discussions regarding interpretation of the shareholder approval rules. Depending on the circumstances, listed companies should discuss questions relating to shareholder approval and their potential transactions with their counsel and potentially NYSE representatives sufficiently early for the calling of a shareholders’ meeting and the solicitation of proxies where shareholder approval may be involved.

Stuart H. Gelfond is a partner in Fried Frank’s Corporate Department and co-head of the firm’s Capital Markets practice, resident in the New York office. Burcin Eren is a Content Manager for the Lexis Practice Advisor Capital Markets & Corporate Governance Module.

Related Content

1. NYSE Listed Company Manual 312.03(b), http://nysemanual.nyse.com/lcm/Help/mapContent.asp?sec=lcm-sections&title=sx-ruling-nyse-policymanual_310.00&id=chp_1_4_12 2. Prior to December 21, 2006, this rule included an exception from the required calculations for issuances of treasury stock. Under that exception, shareholder approval for securities issuances was only required if the securities were not already listed and shares repurchased and held as treasury shares were still considered listed. Under the limited transition period provided by the NYSE, if a company executed a binding contract prior to October 23, 2006, with respect to the issuance of common stock, the existing treasury share exception continues to be available for that transaction.