Council of Institutional Investors

SEC’s Investor Advocate Pledges to Scrutinize NYSE Proposed Rules
Thursday, October 29, 2015
by: Rosemary Lally

Section: CII Governance Alert

In a move that seems to signal a much more aggressive approach, the SEC’s Investor Advocate Rick Fleming forcefully recommended that the commission nix a NYSE proposed rulemaking dealing with sales of additional shares to insiders and related parties. 

In an October 16 memo, Fleming notes that a general lack of awareness of exchange filings among investors generally has prevented scrutiny of the exchanges’ routine proposals. “Those days are now over,” he declares. “Today I make my first formal recommendation to the commission, and it marks the beginning of my office’s efforts to shine a brighter light on the rule changes by the exchanges, either to oppose proposals that may be detrimental to investors or, conversely, to support the efforts of exchanges to amend their rules in ways that benefit investors,” he added.

The NYSE’s proposed rule would allow “early stage” companies with reported revenues of $20 million or less for the past two years to sell shares for cash to directors, officers and those holding at least a 5 percent stake without first obtaining shareholder approval. The cash sales would have to be for new issuances of less than 20 percent of the company’s outstanding common stock. The only blessing that these firms would need for these transactions would come from the audit committee or a comparable committee comprised solely of independent directors.

Currently, the NYSE rules require shareholder approval of the issuance of additional shares to related parties that exceed 1 percent of either the number of shares of common stock or the voting power outstanding before the issuance.

Fleming’s analysis of the proposal notes that the issuance of these new shares would transfer value and voting power from shareholders to related parties. It also notes that when the recipient of new shares is a related party, it created a risk that the company may be engaging in a “sweetheart deal” motivated by conflicts of interest. “Under these circumstances where a transaction with a related party creates a heightened risk of significant harm to existing shareholders, those shareholders should be given the opportunity to evaluate the merits of the transaction and to vote on whether to approve it. The NYSE proposal would strip this right from them,” he notes.

Approval of these transactions by the audit committee is an inadequate substitute for shareholder approval, emphasizes the analysis in Fleming’s memo. “Just as shareholder approval is the standard for equity compensation plans, we believe shareholder approval should be required for sales of shares to related parties.”

More broadly, Fleming takes the NYSE to task for proposing a rule that he says reflects a “race to the bottom” among the exchanges. He also warns that creating a “de facto second tier” on the NYSE with lower standards for smaller companies will lead to significant investor confusion.
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