I. Introduction

New York Stock Exchange LLC (“NYSE” or the “Exchange”) filed on April 16, 2015, with the Securities and Exchange Commission (“Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) ^[1] and Rule 19b-4 thereunder,^[2] a proposed rule change to exempt early stage companies from having to obtain shareholder approval before issuing shares to related parties, affiliates of related parties, or entities in which a related party has a substantial interest. The proposed rule change was published for comment in the Federal Register on May 6, 2015.^[3] The Commission received no comment letters on the proposal. On June 18, 2015, the Commission designated a longer period for Commission action on the proposed rule change ^[4] and on August 4, 2015, initiated proceedings under Section 19(b)(2)(B) of the Act ^[5] to determine whether to approve or disapprove the proposed rule change.^[6] In response to the Order Instituting Proceedings, the Commission received a comment letter from the Exchange and Amendment No. 1 to the proposed rule change.^[7] The Commission also received a recommendation regarding the proposed rule change from the Office of the Investor Advocate (“OIAD”) ^[8] and a comment letter.^[9] On October 30, 2015, the Commission extended the time period for Commission action ^[10] and on November 12, 2015, the Exchange submitted a letter responding to the comments.^[11] On December 10, 2015, the Exchange filed Amendment No. 2 to the proposed rule change.^[12] This order approves the proposed rule change, as modified by Amendment Nos. 1 and 2.

II. Description of the Proposed Rule Change, as Modified by Amendment Nos. 1 and 2

The Exchange proposes to amend Sections 312.03(b) and 312.04 of the Listed Company Manual (“Manual”) to provide an exemption to an “early stage company” listed on the Exchange from having to obtain shareholder approval, under certain circumstances, before issuing shares of common stock, or securities convertible into or exercisable for common stock, to a (1) director, officer ^[13] or substantial security holder ^[14] of the company (“Related Party” or “Related Parties”), (2) subsidiary, affiliate or closely-related person of a Related Party or (3) company or entity in which a Related Party has a substantial direct or indirect interest (together, a “Proposed Exempted Party” or “Proposed Exempted Parties”).^[15] In particular, shareholder approval will no longer be required under Section 312.03(b) for an “early stage company,” before the issuance of shares for cash to a Proposed Exempted Party, provided that the company's audit committee or a comparable committee comprised solely of independent directors reviews and approves of all such transactions prior to their completion.^[16] Today, shareholder approval is required prior to the issuance of shares, among other things, where the number of shares to be issued to the Proposed Exempted Party exceeds either 1% of the number of shares of common stock or 1% of the voting power outstanding before the issuance (or 5% of the number of shares or voting power, if the Related Party is classified as such solely because it is a substantial security holder, and 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 ( printed page 821) company's common stock).^[17] Shareholder approval is also required for issuances relating to 20% or more of the company's common stock, and prior to any issuance that will result in a change of control.^[18]

In addition, the Exchange proposes to amend Section 312.03(b) to make clear that the proposed exemption will not be applicable to a sale of securities by a listed company to any person subject to the provisions of Section 312.03(b) in a transaction, or series of transactions, whose proceeds will be used to fund an acquisition of stock or assets of another company where such person has a direct or indirect interest in the company or assets to be acquired or in the consideration to be paid for such acquisition.^[19]

The Exchange also proposes to clarify in Section 312.03(b) that the sale of stock to a Related Party that is an employee, director or service provider is subject to the equity compensation rules in Section 303A.08 of the Manual.^[20] Accordingly, an early stage company will be unable to issue securities to a Related Party that is an employee, director or service provider, at a discount to the then-current market price, without complying with the shareholder approval requirements of Section 303A.08. Furthermore, the Exchange proposes to include a statement in Section 312.03(b) that shareholder approval is required if any of the subparagraphs of Section 312.03 require such approval, notwithstanding the fact that the transaction does not require approval under Section 312.03(b) or one or more of the other subparagraphs in Section 312.03.^[21] Therefore, the Exchange states that shareholder approval requirements of Sections 312.03(c) ^[22] and 312.03(d) ^[23] will still be applicable.^[24]

The Exchange also proposes to amend Section 312.04 to include a definition of the term “early stage company.” ^[25] The Exchange proposes to define an early stage company as a company that has not reported revenues greater than $20 million in any two consecutive fiscal years since its incorporation.^[26] The Exchange represents that a company's annual financial statements prior to listing on the Exchange will also be considered when determining if the company should lose its early stage company designation.^[27]

Lastly, the Exchange also proposes to delete obsolete text from Section 312.03 of the Manual related to a limited transition period that is no longer relevant.

III. Summary of Comments Received

As noted above, the Commission received a comment letter on the proposed rule change,^[28] the OIAD Recommendation,^[29] and two supplemental submissions from the Exchange.^[30] The OIAD and the comment letter each recommended that the Commission disapprove the proposed rule change.^[31]

A. Dilution of Economic and Ownership Interest

OIAD expressed the view that the proposed rule change is inconsistent with investor protection because it could result in economic dilution of the value and ownership control of an existing shareholder's interest in an early stage company.^[32] OIAD reasoned that the proposed rule change could allow shares of an early stage company to be sold to substantial security holders at a discount to book or fair market value without shareholder approval unless the transaction exceeded twenty percent of outstanding shares or resulted in a change of control of the issuer.^[33] OIAD stated that “[w]hen new shares are sold at a discount from the greater of book or fair market value, it results in economic dilution” that “reduces the value of an existing shareholder's investment in the issuer.” ^[34]

In addition, OIAD highlighted that “all Related Parties . . . could obtain a significantly larger share of ownership control by paying the then-current market price for additional shares in a private transaction, without a vote of the existing shareholders.” ^[35] In effect, ( printed page 822) OIAD believed that such issuances result in an immediate transfer of value from existing shareholders to the new shareholder who injects a “less-than-proportionate share of capital into the business.” ^[36] Finally, OIAD also noted that current investors in these companies would face potential dilution of their voting interest in connection with issuances to Related Parties.^[37]

In response, the Exchange stated that OIAD's analysis failed to consider circumstances that make it “commercially reasonable to price private placement issuances at a discount to the then current market price.” ^[38] The Exchange stated that “a discount is commercially reasonable because investors in private placements are generally unable to resell the shares they purchase in the public market until either the end of the applicable Rule 144 holding period or such time as the company files and obtains effectiveness of a registration statement.” ^[39] In addition, the Exchange asserted that the resale limitations on restricted securities make them “riskier and more illiquid in the hands of the purchaser in a private placement and therefore less valuable.” ^[40] Accordingly, “it is generally necessary to sell shares in a private placement at a lower price than the prevailing public market price.” ^[41] Moreover, the Exchange stated that a discount in the sale of shares in a private placement should only be viewed as economically dilutive if there are other sources of capital available on better terms.^[42]

The Exchange also noted that Section 312.03(d) of the Manual provides a “significant limitation” on any increase in the relative voting power of Related Parties by requiring shareholder approval of any share issuance that gives rise to a change of control.^[43] As a result, the Exchange represented that “the proposed exemption could never be used as a mechanism for obtaining overall control of a listed company without shareholder approval.” ^[44] Furthermore, the Exchange asserted that “the voting rights of existing shareholders are not being diluted in any unfair manner” because “investors in any private placement will receive voting rights on the same terms as all other shareholders.” ^[45]

B. Time-Sensitive Situations

OIAD suggested that the Exchange's existing rules already provide a way for early stage companies to address time-sensitive situations without first obtaining shareholder approval.^[46] Specifically, OIAD identified Section 312.05 of the Manual as providing “NYSE-listed issuers assistance when the delay in securing shareholder approval would seriously jeopardize the financial viability of the enterprise.” ^[47]

In response, the Exchange stated that OIAD's suggested application of Section 312.05 is “inconsistent with the language and longstanding application of the limited exemption from obtaining shareholder approval.” ^[48] The Exchange stated that the intent and current application of Section 312.05 is only for circumstances where “a bankruptcy filing is the only realistic alternative” for a company.^[49] In other words, the exemption is “intended for use in a crisis” and not as a “useful tool to enable [e]arly [s]tage [c]ompanies to meet their ongoing capital needs.” ^[50] Furthermore, as “illustrative of the fact that the exemption is rarely a realistic option,” the Exchange highlighted the fact that it has not received a single financial distress exemption application in the last year.^[51]

C. Audit Committee Approval

OIAD stated that the audit committee (or a comparable committee of independent directors) approval requirement is not an adequate substitute for a shareholder vote on Related Party transactions,^[52] explaining that “[a]lthough the audit committee performs many critical functions that serve to protect the interests of investors, an audit committee will not always reach the same conclusion as shareholders regarding the best interest of the company.” ^[53] As a result, OIAD believed that certain corporate actions that significantly impact shareholders' interests should be subject to shareholder approval, similar to the standard for equity compensation plans.^[54] The Order Instituting Proceedings also raised questions about whether the audit committee would be an appropriate substitute for the approval of shareholders.^[55]

In response, the Exchange stated that directors owe a fiduciary duty to the shareholders they represent and can be held personally liable for any violation of that duty.^[56] The Exchange further noted that independent directors are often well-positioned to evaluate related party transactions because of their knowledge of company affairs.^[57]

D. Reduced Qualitative Standards for Listed Companies

OIAD expressed concern that the proposal reflects a “race to the bottom” among the exchanges,^[58] believing that the Commission “should be encouraging the exchanges to enhance their standards, not devolve to the lowest common denominator because of competitive concerns.” ^[59] OIAD stated that investors have an expectation that listed companies on NYSE are subject to heightened qualitative listing standards.^[60] Given these public expectations, OIAD believed “it is inadvisable to create what could be considered a de facto second tier on the NYSE, with lower corporate governance standards for smaller companies,” ^[61] warning that this could lead to “significant investor confusion” about the listing standards on the Exchange because not all listed companies would have “the same standards of accountability.” ^[62]

In response, the Exchange stated that the concerns of creating a “ de facto two-tier exchange” and “race to the bottom” are misplaced because only a limited number of companies would qualify for the proposed exemption.^[63] In addition, the Exchange emphasized that the proposal would only provide an exemption to early stage companies from shareholder approval for transactions that would also be exempt from shareholder approval under the exchange listing rules of NASDAQ and NYSE MKT.^[64]

E. Impact of Proposal on Efficiency, Competition, and Capital Formation

OIAD stated that the Notice does not provide sufficient information for the Commission to evaluate the proposal's impact on efficiency, competition, and capital formation, under Section 3(f) of the Act,^[65] in particular highlighting that the Notice does not provide a “count or description of the current NYSE-listed companies that would qualify for the proposed exemption, nor is there a count or description of the larger universe of such companies listed on other exchanges or quoted over-the-counter.” ^[66] OIAD also stated that the Notice did not describe how many companies list (or delist) in a given year and how often, if ever, such companies accessed capital through private placements to Related Parties.^[67] OIAD further emphasized that there is no description of the cost imposed on companies seeking shareholder approval in those instances, or the suggestion that any of those companies experienced issues with the level of access to capital afforded by NYSE's listing standards.^[68] OIAD suggested that the Exchange obtain information regarding NASDAQ-listed companies that would qualify as early stage companies on the Exchange,^[69] asserting that “such information would allow for a data-driven and meaningful consideration of the proposed rule's impact on efficiency, competition, and capital formation.” ^[70]

In response, the Exchange provided data on the impact of the proposal. The Exchange stated that there are currently 21 listed companies (out of 2,133 operating companies listed on the Exchange) that would qualify as an early stage company under the proposal.^[71] Based on the data provided, the Exchange asserted that the impact of the proposal would be minimal as the number of early stage companies “is tiny both in absolute terms and as a percentage of listed companies (less than 1%).” ^[72] In addition, the Exchange highlighted from the data that the availability of the proposed exemption to early stage companies would typically be for a limited period.^[73] The Exchange also stated that it did not believe data on NASDAQ-listed companies would be “particularly helpful” given that “a large percentage of NASDAQ listed companies do not qualify for listing on the Exchange and that transfers between the two exchanges are relatively infrequent.” ^[74]

In addition, the Exchange explained that the costs to comply with the proposed exemption will vary depending on the company and, among other things, the number and type of shareholders.^[75] Based on the Exchange's experience in the listing of early stage companies on its affiliated exchange, NYSE MKT, the Exchange stated that such listed companies are “frequently highly dependent on capital infusions from private placements in which management and significant shareholders participate to enable them to continue their operations until they reach the point of commercialization.” ^[76] The Exchange represented that these companies frequently raise capital in transactions that would have required shareholder approval under Section 312.03(b), but to which shareholder approval requirements are not applicable under NYSE MKT or NASDAQ rules.^[77] Furthermore, the Exchange stated that it believed that, “while the companies that would avail themselves of the proposed exemption would likely be very small, the alternative could be very significant to the survival and success of those that utilize it.” ^[78]

IV. Discussion and Commission Findings

After careful review, the Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange.^[79] In particular, the Commission finds that the proposed rule change is consistent with Section 6(b)(5) of the Act,^[80] which requires, among other things, that the rules of a national securities exchange be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest; and are not designed to permit unfair discrimination between customers, issuers, brokers, or dealers. The Commission recognizes that some commenters did not support the proposed rule change. The Commission, however, must approve a proposed rule change if it finds that the proposed rule change is consistent with the requirements of the Act and the ( printed page 824) applicable rules and regulations thereunder.^[81]

The development and enforcement of meaningful corporate governance listing standards for a national securities exchange is of substantial importance to financial markets and the investing public, especially given investor expectations regarding the nature of companies that have achieved an exchange listing for their securities. The corporate governance standards embodied in the listing standards of national securities exchanges, in particular, play an important role in assuring that exchange-listed companies observe good governance practices, including safeguarding the interests of shareholders with respect to certain potentially dilutive transactions.^[82] Commenters raised several concerns with the proposed rule change.

As discussed above, OIAD noted that the proposed rule change could result in economic dilution of the value and ownership control of an existing shareholder's interest in an early stage company.^[83] OIAD expressed concern that the potential for a greater percentage of shares to be issued at a discount to substantial security holders, without a shareholder vote, could lead to harmful dilution of the economic value of existing shares.^[84] OIAD also expressed concern that the voting power of existing shareholders could be inappropriately diluted as a result of the proposal's increased flexibility to issue additional shares at fair market value to all Related Parties.^[85]

The Commission has carefully considered these and the other concerns expressed by the commenters. The Commission nevertheless finds, however, that the proposed rule change, on balance, is consistent with the Act, for the reasons set forth below.

The Commission acknowledges that the proposed rule change, by expanding the circumstances under which an early stage company could issue additional stock without shareholder approval, raises concern that such companies could engage in transactions with a harmful dilutive impact on existing shareholders. In the Commission's view, however, the significant proposed limitations on the ability of early stage companies to engage in such transactions, together with the countervailing potential benefits to the ability of small issuers to efficiently raise capital, and to fair competition among the listing exchanges, sufficiently offset those risks. Because the proposal allows early stage companies the flexibility to meet their financing needs while still preserving significant shareholder rights afforded under the other provisions of Section 312.03, the Commission finds that the proposal is consistent with investor protection and the public interest.

First, the Commission notes that the additional flexibility provided by the proposed rule change for early stage companies to issue additional stock without shareholder approval is limited by other important Exchange rules. For one, any discounted issuance of stock to an early stage company's officers or directors, or to a substantial security holder that is an employee or other service provider, would require shareholder approval under the Exchange's equity compensation rules.^[86] Shareholder approval also generally is required for an issuance of additional stock, even at fair market value, that is in excess of 20% of an issuer's outstanding shares.^[87]

In addition, the proposed rule change requires that, for all such transactions, the approval of the early stage company's audit committee, or a comparable committee comprised solely of independent directors, first be obtained. The Commission has long acknowledged the important role an independent Board committee has in protecting shareholders from potential conflicts of interest.^[88] The Commission agrees with the Exchange that an independent committee review and approval of these transactions is an appropriate safeguard to protect shareholder interests. As noted by the Exchange, the knowledge of independent directors of the company's business affairs, together with their fiduciary obligations to shareholders, make them well-positioned to effectively protect shareholder interests under these circumstances.^[89]

The Commission believes that an independent director committee is a proper forum, in executing its fiduciary duty, to review and approve these transactions and can appropriately protect shareholder interests. Additionally, the Commission notes that the Exchange, as a self-regulatory organization, is required, among other things, to enforce compliance with all Exchange rules, including its listing standards. To help the Exchange appropriately surveil its listed companies for compliance with the shareholder approval rules, under Section 703.01(A) of the Manual, listed companies are required to submit in writing, in advance of any issuance, a supplemental listing application to issue any additional shares of a listed security, including shares issued in a private transaction. Section 703.01(A) also requires that the company state whether shareholder approval is required under Exchange rules and, if so, when it was obtained. These provisions facilitate the monitoring of listed companies for compliance with the shareholder approval rules under the Manual and should aid the Exchange in monitoring compliance with the requirements for issuing private securities under the exemption, as well as whether shareholder approval is required under the change of control or equity compensation rules, among others.^[90] As provided by the Act, any future changes to exchange listing standards, including the shareholder ( printed page 825) approval provisions, will have to be submitted under Section 19(b) of the Act. The Commission will, of course, evaluate any future proposed rule changes to exchange listing standards for consistency with the requirements under the Act, including to ensure adequate investor protection for shareholders.

The Commission also believes that facilitating the ability of early stage companies to efficiently raise needed capital under the limited circumstances permitted by the proposed rule change is in the public interest. By definition, early stage companies are those that have not yet generated significant revenue from operations, and may therefore need to raise capital quickly in order to fund their ongoing operations. Allowing early stage companies to flexibly raise capital, subject to audit committee approval and the other limitations described above, but without the delays inherent in a shareholder vote, could improve the business prospects of such companies and ultimately inure to the benefit of shareholders.

Further, the Commission recognizes that, as noted by the Exchange, the rules of other listing exchanges such as NASDAQ and NYSE MKT permit early stage companies similar flexibility in issuing additional stock without shareholder approval. While the Commission acknowledges OIAD's concern about a “race to the bottom” by the exchanges, the Commission also is cognizant of the fact that the exchanges operate in a highly competitive environment, including with respect to the listing of issuers. If the Commission were not to allow the Exchange to provide the same flexibility to listed companies offered by other listing markets, the Exchange Act goal of facilitating fair competition among the exchanges could be undermined. At the same time, investor protection might not materially improve, since early stage companies seeking the flexibility proposed by the Exchange simply may choose to list on NASDAQ or NYSE MKT.

The Commission notes that, in determining to approve the Exchange's proposed rule change, the Commission has considered, under Section 3(f) of the Act, whether the action will promote efficiency, competition, and capital formation.^[91] The proposed rule change would allow early stage companies to more timely access the capital markets when they critically need funds. To the extent that the proposed rule change would make it easier for such companies to raise the needed capital and continue their operations, it would likely improve the allocation of capital thus enhancing efficiency. On the other hand, if the rule change is primarily used by Related Parties to more easily gain control of a company and in the process expropriate other (minority) shareholders, then the proposed rule change could have a negative effect on efficiency. Given that Section 312.03(d) of the Manual significantly limits any increase in the relative voting power of Related Parties by requiring shareholder approval of any share issuance that gives rise to a change of control, the proposed rule change is unlikely to lead to significant minority shareholder expropriation.

By making it less costly for early stage companies to raise additional capital they need to continue their operations, the proposed rule change will promote capital formation. Allowing these companies to stay afloat and grow also increases the likelihood that they would raise more funds in the future, further enhancing capital formation. In addition, the proposed rule change could enhance competition by allowing NYSE to compete for the listing of these companies in a competitive environment that allows these companies to list on other markets such as NASDAQ or NYSE MKT. In conclusion, the Commission believes that the proposed rule change could promote efficiency, competition, and capital formation.

Finally, the Commission acknowledges the important contributions that are being made by its Investor Advocate on a range of important policy matters, including those raised by individual proposed rule changes filed by the exchanges, such as the proposal that is the subject of this Order. While the Commission today determined that the NYSE's proposed rule change is consistent with the Act, the Commission encourages the Investor Advocate to continue bringing important matters to our attention, including identifying circumstances where incremental changes, while consistent with the Act, may be contributing to cumulative impacts that harm investors or impede fair and orderly markets. In this instance, the comments of the Investor Advocate prompted the Exchange to bolster the justification for its proposal, including through the provision of additional data, and to clarify its limited scope. As a result, the extent and quality of information available to the Commission in considering the proposed rule change was substantially enhanced, to the benefit of investors and all market participants. As our markets and regulatory structure continue to evolve, the views of the Investor Advocate will remain critical in helping the Commission further its mission of protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation.

For the reasons discussed above, the Commission believes that the proposed rule change, as modified by Amendment Nos. 1 and 2, is consistent with the Act.^[92]

V. Solicitation of Comments

Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether this filing, as modified by whether Amendment Nos. 1 and 2, is consistent with the Act. Comments may be submitted by any of the following methods:

Electronic Comments

• Use the Commission's Internet comment form (http://www.sec.gov/​rules/​sro.shtml); or
• Send an email torule-comments@sec.gov. Please include File Number SR-NYSE-2015-02 on the subject line.

Paper Comments

• Send paper comments in triplicate to Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.

VI. Accelerated Approval of Proposed Rule Change, as Modified by Amendment Nos. 1 and 2

The Commission finds good cause, pursuant to Section 19(b)(2) of the Act, to approve the proposed rule change, as modified by Amendment Nos. 1 and 2, prior to the 30th day after the date of publication of Amendment Nos. 1 and 2 in the Federal Register . As discussed above, Amendment No. 1 merely clarified that the proposed exemption from shareholder approval transactions involving the sale of stock for cash by an early stage company applies not only to a Related Party, as originally proposed, but also to a subsidiary, affiliate or other closely-related person of a Related Party; or any company or entity in which a Related Party has a substantial direct or indirect interest.^[93] Similarly, Amendment No. 2 clarified that (i) an early stage company may not use the proposed exemption to fund an acquisition of stock or assets of another company that would otherwise require shareholder approval under Section 312.03(b) of the Manual; (ii) any sale of a listed company's securities at a below-market price to an employee, director or service provider constitutes equity compensation under Section 303A.08 of the Manual and is therefore subject to the shareholder approval requirements under that rule; and (iii) shareholder approval of any issuance is required if any of the subparagraphs of Section 312.03 require such approval, notwithstanding the fact that the transaction does not require approval under Section 312.03(b) or one or more of the other subparagraphs.^[94] The Commission believes that these revisions provide greater clarity on the application of the proposal and remove uncertainty as to which transactions the Exchange proposes to exempt from shareholder approval under Section 312.03.

Accordingly, the Commission finds good cause for approving the proposed rule change, as modified by Amendment Nos. 1 and 2, on an accelerated basis, pursuant to Section 19(b)(2) of the Act.

VII. Conclusion

It is therefore ordered, pursuant to Section 19(b)(2) of the Act ^[95] that the proposed rule change (SR-NYSE-2015-02), as modified by Amendment Nos. 1 and 2, be, and hereby is, approved.

All submissions should refer to File Number SR-NYSE-2015-02. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site ( http://www.sec.gov/​rules/​sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for Web site viewing and printing in the Commission's Public Reference Room, 100 F Street NE., Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of the ( printed page 826) filing also will be available for inspection and copying at the principal office of the Exchange. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR-NYSE-2015-02 and should be submitted on or before January 28, 2016.