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ANALYSIS: Easing Direct Listing Rules Sparks Expectation, Unease

Sept. 30, 2020, 8:31 AM

The rules for direct listings are likely changing soon on the NYSE and Nasdaq exchanges. The SEC has approved NYSE-proposed changes to its direct listing rules, and Nasdaq’s request for its version is pending. However, a petition by the investor advocacy group Council of Institutional Investors (CII) has stayed the SEC’s NYSE order, and a debate over the merits of these rule changes is heating up.

Direct listings were little used by large companies until music streaming service Spotify registered shares on behalf of shareholders in 2018. They offer the benefits of no lockup period for insiders selling shares; cheaper fees because no underwriter is used; and an opening public price determined by auction, not an underwriter. An auction means more share price upside is captured by selling shareholders, such as private equity. If implemented, the NYSE’s new rule would further increase the attractiveness of direct listings, principally by allowing issuers to raise capital in the public offering. Current rules do not allow such primary direct listings.

Some are concerned, however. The CII complains that the new NYSE rule adversely impacts the ability of shareholders to trace purchased shares to those offered in the registration statement, an essential element for litigation under Section 11 of the Securities Act. Section 11 imposes strict liability for material misstatements or omissions in a registration statement, a much easier standard for a plaintiff to meet than the reckless or intentional misconduct typically applied under other theories.

Without underwriters, investors could be harmed by increased share price volatility, potentially less robust disclosures, and no lockup period, thereby allowing insiders to sell their shares at inflated prices. Other downsides could be insufficient market liquidity and dilution to existing shareholders.

No date has been set for the SEC to complete its CII petition review.

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