Private Secondary Markets: Contrast With Listed Company Regulation

In the emergence of secondary markets for private company stock, the latest development is Nasdaq’s sponsorship of a private secondary market. These markets allow privately held companies (sometimes with hundreds of stockholders) to have the benefits of a liquid market in their securities without subjecting themselves to the restrictions of an exchange listing. At the same time, Nasdaq and the other stock exchanges have been imposing even more governance requirements and restrictions on listed public companies.

Secondary markets for private company stock are not new. SharesPost, Inc. and SecondMarket have been operating online secondary markets that trade in private shares for a few years. Each works with private companies that choose to list on their platforms and want to provide employees, venture backers and other existing shareholders with liquidity opportunities by privately placing their shares with qualified investors. Private resale markets gained popularity with the rise of richly-valued Silicon Valley-based technology companies. Shares of Facebook and LinkedIn were highly sought-after prior to their IPOs and were available in the private secondary market. Currently, eharmony, foursquare, Pinterest, Spotify and tumbler are among the many private companies currently listed on SharesPost’s website and SecondMarket’s website.  Start-ups have had much more difficultly going public in recent years.  This is a result of a variety of factors, a discussion of which is beyond the scope of this post, but the cost of Sarbanes-Oxley compliance, a recessionary economy and decimalization are often cited.  Companies that do go public take more time to do so, which means that private company shareholders (including employees who receive equity as a meaningful portion of their compensation) hold illiquid stakes in companies for a longer period of time. The resulting pent up demand for liquidity presents an opportunity for the private secondary markets.

Most recently, Nasdaq has announced that it is joining forces with SharesPost, Inc.  to establish The Nasdaq Private Market, a marketplace for the resale of private stock.  According to the press release, the venture “combines NASDAQ OMX's market and operating expertise as well as resources with SharesPost's leading web-based platform.”

Adding to the attractiveness of private secondary markets is the recent easing of registration requirements under The JOBS Act. Prior to its adoption in mid-2012, companies with at least $10 million in assets were required to register under Section12(g) of the Exchange Act if their number of record shareholders expanded beyond 499.  This subjected them to the burdensome reporting obligations applicable to public companies, including obligations to file detailed annual and quarterly reports with the SEC.  By participating in the private secondary market and expanding their shareholder ranks, companies risked having to register with the SEC before they were ready. Facebook, an active participant in the secondary markets prior to its IPO, fell prey to 500 shareholder rule and was forced to go public in 2012.  The JOBS Act increased the shareholder threshold to 2,000 as long as no more than 499 are non-accredited (shareholders who received shares under a company's equity compensation plans and investors who purchased securities pursuant to the crowdfunding exemptions are excluded altogether). Because participants in the private secondary market are accredited investors, there is less risk of over-expanding a company’s shareholder base through trading in the secondary market.

Another reason for companies to stay private for longer is the increasingly more stringent regulation by the SEC (Sarbanes-Oxley) and the national securities exchanges.  An example is Nasdaq’s recent proposed new listing standard that will require all companies listed on Nasdaq to establish and maintain an internal audit function. The proposal permits outsourcing of the function to any third party service provider other than the company's independent auditor and charges the audit committee with sole responsibility to oversee the internal audit function.  Although many Nasdaq listed companies already have a separate internal audit function, this will certainly add burden and expense to smaller public companies that may not. Yes, the NYSE already has a comparable listing standard in place, however the NYSE is generally considered to be the market for well-established companies that are more likely to have separate internal audit functions in place.

Comment. As it proposes increased regulation of its public securities exchanges, Nasdaq is also recognizing that the securities environment in general (including as a result of its own actions) may be ripe for a rise secondary trading of private company stock. In fact, Nasdaq bet on it when it established the Nasdaq Private Market with SharesPost, as described above. It will be interesting to monitor the progress and success of the joint venture. Is Nasdaq trying to get the best of both worlds? 

Image © Copyright 2006, The Nasdaq Stock Market, Inc.; Reprinted with the permission of The Nasdaq Stock Market, Inc.; Photo credit: Rob Tannenbaum/Nasdaq


"What's Goin' On"?

informationSeveral new reports have been published that provide valuable information about what's going on in the public company world. Here are two that just came out:

    Pearl Meyer & Partners released a survey report covering companies' attitudes toward Say-on-Pay, which is currently required for TARP recipients but will not be required for other public companies until at least 2011. The survey found that most respondents were not very concerned about Say-on-Pay and are not yet taking specific steps to plan for shareholders advisory votes. The Pearl Meyer firm reports that virtually all advisory votes have passed, mostly by a sizeable majority. However, the firm cautions that institutional shareholders may get tougher on Say-on-Pay votes in the future. The survey report recommends some specific steps companies can take over the next several months to plan for Say-on-Pay.

    Frederick W. Cook & Co. released a report of its study of non-employee director compensation at the 100 largest New York Stock Exchange companies and the 100 largest Nasdaq companies. The study found that compensation levels generally stabilized in 2009 after several years of increases, which had tracked increased director responsibilities under the Sarbanes-Oxley Act of 2002. The study also found that the compensation mix changed, with more companies moving director equity awards out of stock options and into stock awards. Also, the declines in the equity markets had a significant impact on equity award values, especially at Nasdaq companies. The study outlines median compensation levels at these companies and examines a number of compensation practices.

One more update - hot off the presses: I noticed that RiskMetrics today published some of its 2010 policy information, which applies to all shareholder meetings occurring on or after February 1, 2010. The more comprehensive proxy voting guidelines will be published in December. However, the just-released documents shed some light on RiskMetrics' evaluation of compensation and governance practices for the 2010 season. It appears that RiskMetrics will make some changes to its approach in making recommendations on Say-on-Pay votes and other compensation-related votes. I will report further on this next week.

Be Afraid, Be Very Afraid - Preparing for the Elimination of Broker Discretionary Voting

As described previously, on July 1, 2009, the SEC approved by a 3-2 vote an amendment to New York Stock Exchange Rule 452 to eliminate broker discretionary voting in uncontested elections of directors. Of all the recent proposals (see the ON Securities Cheat Sheet), this was the first to be adopted, and this change may have the biggest practical impact on corporate governance for most companies. The rule change is effective for shareholder meetings held on or after January 1, 2010, and it is likely to make it more difficult to get affirmative votes in favor of management's slate of directors.


So for management of a public company, is this your worst nightmare? Maybe it's a little early to start screaming. But at the very least, it's not too early to do some advance planning to avoid surprises for the board. And for the in-house attorneys I work with, it's always a good idea to avoid surprises for the board. Or you WILL have something to scream about.

So what should a company do to prepare? Georgeson, a leading proxy solicitation firm, recently did a good explanation of the possible impact of the amendment, including three main tips:

    Analyze - run some numbers to determine the possible impact of the amendment on your next election, including the possible impact of factors that might lead proxy advisory firms like ISS/RiskMetrics to recommend a vote against the incumbents.

    Communicate - develop a communication plan to educate retail investors on the importance of voting and a last-minute "get out the vote" campaign, just in case.

    Prepare - develop a damage control plan in case of a large percentage of negative votes (or a failed election, in the case of a company that has adopted majority voting for directors).

I talked to one in-house attorney who has started to run analyses of historical vote patterns to predict how the next election will come out. What is your company doing? And how much impact do you think the amendment to the broker voting rules will have? Post a comment below or send me an e-mail.

The SEC's July 1 actions in context; Singing Fish is a hit

The SEC takes action on July 1, but that's not the whole story.

On July 1, 2009, the SEC voted to take several actions:

    The Commission proposed rules that would clarify the statutory requirement that TARP recipients hold annual stockholder votes on compensation ("Say-on-Pay").

    The Commission proposed revisions to the compensation disclosure rules that, among other things, would (1) disclose the relationship to risk of a company's overall compensation policies (not just policies covering top executives) and (2) disclose potential conflicts of interest of compensation consultants.

    In probably the most important move, the Commission approved the New York Stock Exchange's proposal to eliminate discretionary voting in elections of directors. Therefore, brokers must receive instructions from the beneficial owner before voting. The conventional wisdom is that brokers acting without instructions generally vote in favor of management's slate, and that this change will reduce the percentage of shares voting for the director candidates in routine elections. The Wachtell Lipton law firm presented an interesting analysis of this issue in March, taking the position that the current broker votes in favor of management are a pretty good proxy for the votes of retail stockholders, who generally support management's candidates.

However, to understand the impact of the July 1 actions, it is necessary to understand other current developments, some of which would have an even greater impact on a broader segment of companies:
    The Commission's Say-on-Pay proposals covered only TARP recipient companies. However, the Shareholder Bill of Rights Act introduced in the Senate by Senator Schumer, if adopted, would mandate Say-on-Pay for all public companies, as would two other bills currently being considered by Congress.

    The Commission did not require that public companies adopt a specific structure to assess risk and ensure that compensation practices are consistent with the company's risk profile. However, the ARRA and the Treasury's interim final rules currently require the compensation committees of TARP recipients to perform specific risk management functions. Also, the Schumer bill would require that the board of directors of all public companies form a risk committee of independent directors to report to the board about the company's risk profile and the appropriateness of its compensation practices.

    The elimination of discretionary voting by brokers takes on added importance because it could alter the balance of power between management and activist stockholders, especially for companies that have adopted majority vote standards in director elections. This shift would compound the potential increase in power by institutional investors that would result from the Commission's controversial proxy access proposal, reported here, which would allow large stockholders to nominate director candidates who would be included in management's proxy statements.

The bottom line: you need a scorecard to keep everything in context. The ON Securities Blog is working on a scorecard that will cover the SEC proposals, the Schumer bill, other pending bills and the Treasury regulations under TARP and the stimulus bill. What would you like to see covered? Send me an e-mail and let me know.

Maslon Small Public Company Forum's Inaugural Event is a success (singing fish and all).

On June 24, 2009, I participated in the inaugural event of the Maslon Small Public Company Forum, which included presenters from Maslon, Baker Tilly Virchow Krause, Carver Moquist & O'Connor, Feltl and Company and Internal Control & Anti-Fraud Experts, LLC. Course materials and podcasts of the presentations are available at the Small Public Company Forum website, which we hope will be a great resource for small public companies across the region.

For my presentation on underwater options entitled "Underwaterworld", I presented the "world's leading expert on underwater options": Big Mouth Billy Bass, the famous singing fish. You can watch Billy's full performance here. In his immortal words, once you solve your company's underwater options problem, you can take his advice: "Don't Worry, Be Happy!"